Provisions

A provision takes into account an expected expense, showing it as a liability on the balance sheet. A company will create a provision in the current period when the likely liability becomes apparent, thus reducing the reported profit.

For example, consider a company that has entered into a contract on which it then becomes evident it will make a loss. The loss will only actually occur (i.e. the payments that will make it unprofitable will only happen) in a future year. However, if once it is known that the loss is probably a provision must be made in the accounts and this will reduce the profits in the year the period in which the provision is made.

One problem with provisions is that they can be used to smooth profits. A company can make make provisions than usual in a good year (reducing that year's profits) and reverse them in a bad year (boosting that year's profits). Accounting standards have been tightened in order to make this harder. In particular, IFRS no longer allow general provisions, but only specific provisions tied to identified past events that lead to a probable future loss.

However, some anticipated losses that would previously have been shown as general provisions (e.g. provisions for doubtful debt, or for the loss in resale value of an asset) will still appear in the accounts as impairments, so less has changed than might appear to be the case.

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