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　　Question 1 (Q3/December 2003)
　　IAS 37’ Provisions, Contingent Liabilities and Contingent Assets’ was issued in 1998. The Standard sets out the rinciples of accounting for these items and clarifies when provisions should and should not be made. Prior to its issue, the inappropriate use of provisions had been an area where companies had been accused of manipulating the financial statements and of creative accounting.
　　Required:
　　(a) Describe the nature of provisions and the accounting requirements for them contained in IAS 37.(6 marks)
　　(b) Explain why there is a need for an accounting standard in this area. Illustrate your answer with three practical examples of how the standard addresses controversial issues. (6 marks)
　　(a) IAS 37 ‘Provisions, Contingent Liabilities and Contingent Assets’ only deals with those provisions that are regarded as liabilities. The term provision is also generally used to describe those amounts set aside to write down the value of assets such as depreciation charges and provisions for diminution in value (e.g. provision to write down the value of damaged or slow moving inventory). The definition of a provision in the Standard is quite simple; provisions are liabilities of uncertain timing or amount. If there is reasonable certainty over these two aspects the liability is a creditor. There is clearly an overlap between provisions and contingencies. Because of the ‘uncertainty’ aspects of the definition, it can be argued that to some extent all provisions have an element of contingency. The IASB distinguishes between the tow by stating that a contingency is not recognized as a liability if it is either only possible and therefore yet to be confirmed as a liability, or where there is a liability but it cannot be measured with sufficient reliability. The IASB notes the latter should be rare.
　　The IASB intends that only those liabilities that meet the characteristics of a liability in its Framework for the Preparation and Presentation of Financial Statements should be reported in the balance sheet.
　　IAS 37 summarises the above by requiring provisions to satisfy all of the following three recognition criteria:
　　- there is a present obligation (legal or constructive) as a result of a past event;
　　- it is probable that a transfer of economic benefits will be required to settle the obligation;
　　A provision is triggered by an obligating event. This must have already occurred, future events cannot create current liabilities. The first of the criteria refers to legal or constructive obligations. A legal obligation is straightforward and uncontroversial, but constructive obligations are a relatively new concept. These arise where a company creates an expectation that it will meet certain obligations that is not legally bound to meet. These may arise due to a published statement or even by a pattern of past practice. In reality constrictive obligations are usually accepted because the alternative action is unattractive or may damage the reputation of the company. The most commonly quoted example of such is a commitment to pay for environmental damage caused by the company, even where there is no legal obligation to do so.