Section 21: Provisions and Contingencies
Section 21 applies to all provisions, contingent liabilities and contingent assets, except those covered by other sections of FRS 102. 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?
Section 21 requires a number of disclosure which were not required under old GAAP, these being disclosures:
- detailing the expected amount of payments resulting from an obligation; and
- detailing the nature and business purpose of any financial guarantee contracts in scope of the standard regardless of whether any provision is required or contingent liability is to be disclosed (Section 21.17A).
What is different?
Section 21 makes it clear that provisions should not be recognised for future operating losses. Old GAAP (FRS 12) 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 netting against future profits up to the date of termination or sale. Section 21 does not allow for such a provision to be created.
Section 21 does not require the below disclosures which were previously required under Old GAAP:
- Major assumptions concerning future events that may affect the amount required to settle an obligation.
- A separate line item in the reconciliation of opening and closing balances detailing the movement as a result of discounting instead this can be shown in the additions line (Section 21.14 (a) (ii)).
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.
Section 21 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 21 applies (Section 21.14). This differs under old GAAP 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 21 and FRS 12 so that they can adequately identify possible adjustments at the date of transition.
Review their client portfolio for clients who have given financial guarantees as further detail will need to be disclosed in the FRS 102 set of financial statements.
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.