Her Majesty's Revenue and Customs (HMRC) - UK government tax office in London.

Provisions and Contingencies

by David Pritchard, Mander Duffill

Determining whether a provision for either an asset or liability needs to be recognised represents a dilemma regularly faced by accountants. There is further complexity when deciding whether there is a need to disclose contingent assets or liabilities.

This area of accountancy has always attracted attention due to the historic practice where companies would recognise substantial and non-specific provisions. The provisions introduced by companies were very unlikely to materialise into any actual payment and were used to help manipulate a profit or a loss in a given year.

This provides the background for the accounting standard ‘FRS102 The Financial Reporting Standard applicable in the UK and Republic of Ireland, Section 21 Provisions and Contingencies’.

In addition to the accounting standard, there is further taxation consideration to be given as to whether a provision would be allowable by HM Revenue & Customs. Non-specific provisions would be disallowed against corporation tax and therefore the company would lose the tax deduction for that expense. Following the criteria set out by the accounting standard would allow a provision to be recognised in the financial statements and also be an allowable tax deduction.

There are three premises which need to be met in order to recognise a provision:

  1. The entity must have a present obligation that has arisen as a result of a past event;
  2. It is more likely than not that the entity will have to transfer some economic benefit in order to settle an obligation; and
  3. The amount of the obligation can be measured with some degree of reliability.

The first premise is centred around whether there has been a creation of a present obligation. This can come in the form of a legal obligation or a constructive obligation. A legal obligation, as the name suggests, comes from an obligation enforced under the law and is relatively simple to establish from an accountant’s perspective through a review of legal documentation. A constructive obligation is determined by whether there is an expectation in the mind set of others that the client will discharge their obligations. This is far more judgemental and would require further work to conclude whether a constructive obligation exists.

The second premise focuses on whether it is more likely than not that an economic transfer will occur. This can be assessed in a number of ways and even a combination of them all. One of the most common, certainly in terms of legal cases involving clients, involves contact with the client’s solicitor to ask for their opinion as to whether it is more than likely the client will need to pay out for a case. Another involves looking at similar scenarios from previous cases to review and analyse the ‘more likely than not’ criteria against these cases.

The final premise for recognising a provision surrounds the reliability of an estimate. This will again involve contact with legal counsel, review of any documentation received from the court and understanding how the client has calculated a figure, if they have been able to. Obtaining a figure is only half the battle, as it also needs to be reliable. This requires further analysis and challenge, as clients may try to present a lower amount than the actual outcome.

The provision can only be recognised if all three premises are met. If the provision is unable to meet all three, the accountant will have to determine whether there is a requirement for a contingent liability to be disclosed in the financial statements.

A contingent liability represents a possible but uncertain obligation or a present obligation that fails to meet the three premises highlighted above.

The decision to disclose a contingent liability will ultimately rest on whether the possible liability is material. This needs to be assessed from a qualitative as well as a quantitative perspective. The way to determine this is to ascertain whether it would be material for the users and would affect their interpretation of the financial statements.

The guidance provided within FRS102 gives clear guidelines for accountants to use when assessing provisions and this should embolden accountants to challenge clients.


David Pritchard

David Pritchard

Mander Duffill, Chippenham, UK
T: +44 1249 650441
This email address is being protected from spambots. You need JavaScript enabled to view it. ; W: www.manderduffill.com

Mander Duffill is a firm of chartered accountants, and tax and financial advisers, with offices in Chippenham, Devizes and London. Their aim is to provide the best possible service to their clients. They are proud of their history, supporting individuals and businesses for over 70 years.

David Pritchard specialises in research and development claims and providing tax advice on an array of issues. David aims to provide great service to clients and is focused on building strong working relationships to ensure all possible tax efficient opportunities are explored.


Published: GGI Auditing, Reporting & Compliance Practice Group Newsletter, Autumn 2019 l Photo: Magico110 - stock.adobe.com

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