Section 16 – Provisions and Contingencies

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Section 16 – Overview

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Section 16 – Analysis

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Section 16: Provisions and Contingencies

Summary

Section 16 applies to all provisions, contingent liabilities and contingent assets, except those covered by other sections of FRS 105. For example, leases, construction contracts, employee benefits and income tax. It does not apply to executory contracts unless they are onerous contracts.

What is new when compared to previous GAAPs – General?

Section 16 requires less disclosures than was required by old GAAP/FRSSE and FRS 102. FRS 105 only requires disclosure of any financial commitments, guarantees and contingencies not recognised in the balance sheet. It provides no other guidance. The rules with regard to what would require to be disclosed in this note would be determined by the guidance provided in the Section for disclosures relating to contingent liabilities and contingent assets (i.e. contingent liabilities are to be disclosed and contingent assets that are probable should be disclosed).

What is different when compared to FRSSE/old GAAP?

Section 16 makes it clear that provisions should not be recognised for future operating losses. Old GAAP (FRS 12)/FRSSE had the same principal, however, where FRS 3 applied and a decision had been made to terminate an operation (i.e. the entity was committed to the sale or termination of the operation at the balance sheet date) then a provision could be created for future operating losses and netted against future profits up to the date of termination or sale. Section 16 does not allow for such a provision to be created.

For FRS 26 adopters, under old GAAP, financial guarantee disclosures were dictated by FRS 29 which were more detailed and the financial guarantee was required to be fair valued. This is not required under FRS 105 (difference not applicable for FRSSE and non FRS 26 adapters).

Section 16 deals with all provisions, contingent assets and contingent liabilities other than where they are not dealt with by other standards. However, if there are onerous contracts which are not specifically dealt with by the other standards; Section 16 applies. This differs under old GAAP/FRSSE in that where onerous contracts were not dealt with by other standards there was no requirement to apply FRS 12 except for onerous leases.

What are the key points?

A provision should be recognised where there is a present obligation (either legal or constructive) as a result of a past event and where a transfer of economic benefits is probable to settle the obligation and the obligation can be reliably measured.

Provisions are measured at the best estimate of the amount required to settle the obligation at the reporting date and should take into account the time value of money where material. The provision is then adjusted at each reporting date. The unwinding of any discount is included within finance costs.

Contingent assets are not recognised and instead disclosed if their likelihood is probable.

Contingent liabilities are disclosed unless the possibility of an outflow of resources is considered remote in which case no disclosure is required. A contingent liability arises where the outflow of economic benefits cannot be measured reliably or it is not probable that an outflow of economic benefits will be required.

Section 21.17 allows companies not to disclose certain details in relation to provisions, contingent liabilities and assets on the basis it would be prejudicial to a dispute. However, disclosure is required detailing why the entity feels the disclosures cannot be detailed.

The standard provides examples of circumstances in which a provision is required to be made.

What do accountants need to do?

Be aware of the differences between Section 16 and old GAAP/FRSSE so that they can adequately identify possible adjustments at the date of transition.

Recognise there are no differences between FRS 102 and FRS 105 other than in relation to the reduced disclosures.

What do companies need to do?

Review the provisions in the entity to see if disclosures can be stripped out from the financial statements as a result of the new standard.

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