TABLE OF CONTENTS The use of provisions can have a significant impact on a company's financial statements. They arise in many areas of business, and often relate to controversial aspects such as restructuring costs, environmental and decommissioning liabilities. They have often been set up based on management intentions rather than on the existence of a genuine liability.
In the recent past there has been much criticism of the use and abuse of provisions. The main abuse has been that of 'profit smoothing'. In essence this amounts to creating a provision, usually for some intended expenditure, when a company's profits are healthy, and subsequently releasing the provision through the income statement to offset the expenditure when it occurs. This has the effect of reducing the profit in the years in which provisions are made and increasing profits in years they are released. It is known as 'big bath accounting'. It means that provisions created for a specific purpose are aggregated with other provisions and subsequently used to offset expenditures of future years that were not (and should not have been) provided for. Such provisions were often very large and treated as extraordinary or exceptional items. This treatment may have caused some users to disregard the expense in the belief that it was a non-recurring item, thus minimising the adverse impact of the provision. Extreme cases occurred where provisions were deliberately over provided with the intention that their release in...
