The Importance of Accounting Standard - Case Study Example

Student Name: Tutor: Title: Accounting Assignment: AASB 137 Course: AASB 137 Introduction Accounting Standard AASB 137 (provisions, contingent liabilities and contingent assets) is very important in accounting reporting and preparation of financial accounting reports. The objective of the standard is to make sure that suitable measurement bases and recognition criteria are applied to contingent assets, contingent liabilities and provisions and that adequate information is disclosed in the attached notes to help users understand their nature, amount and timing (Bragg, 2010). The standard specifies the time of annual reporting when it applicable and when it is not. Business entities are bound by their future, present and past. Nothing can be overlooked as long as it has a bearing on the performance of the business. The past cannot be wished away and future obligations cannot be overlooked. Provisions and contingencies are important in reconciling the business to its past and future in order to reflect the true picture about its performance. The performance of the business entity when reported without recognizing provisions and contingencies may be misleading if some of the probable happen and the business will not have a means to deal with them because of wishful thinking. This paper explores the importance of AASB 137 to financial reporting giving details why it is important contingencies and provisions to be recognized and measured in business entities’ financial reporting. Provisions have been defined as liabilities of uncertain amount or timing. This is very helpful because provisions are set out in anticipation of occurrence in future where the company expects to spend money. Without provisions being catered by the standard, there would be instability and confusion since other people who categorize provisions as an asset which is not the case. In some countries ‘provision’ has been used to represent other aspects like impairment of assets, depreciation, and doubtful debts. This standard helps companies to cushion themselves against adverse conditions and emergencies. Companies have money to spend in case of unusual occurrences (Collings, 2012). Preparations of final accounts factor in the importance of contingent liabilities, contingent assets and provisions. Generally, all provisions are contingent since they are uncertain in their amount or timing. In this standard the term ‘contingent’ is applied for assets and liabilities that have not be recognized since their existence will be confirmed by the non-occurrence or occurrence of one or more uncertain future events not entirely within the control of the entity. Besides, the term ‘contingent’ is applied for liabilities that do not meet the recognition criteria. Provisions are distinguishable from other liabilities like accruals and liabilities since there is uncertainty in regard to the amount or timing of the future expenditure needed in settlement. On the other hand accruals are normally liabilities to pay for services or goods that have been supplied or received but have not been paid, formally agreed with the supplier or invoiced, including amounts owed to employees. The uncertainty in accruals in regard to timing and amount is less as compared to provisions. The distinction of provisions from accruals is important so as not to result into confusion when preparing final accounts. Moreover, trade payables are liabilities to pay for services or goods that have been supplied or received and have been formally agreed by the supplier or invoiced (Bragg, 2010). Looking at provisions, contingent liabilities and contingent assets, they fall in a different category and it is important for accounts to have AASB 137 in their mind as they prepare final accounts. Accruals are usually reported as part of trade and other payables, on the other hand, provisions are reported separately. AASB 137 requires provision’s recognition when an entity has a present obligation resulting from a past event; it is most likely that outflow of resources embodying economic benefits will be needed in the settlement of the obligation; and a reliable estimate can be determined of the amount of the obligation (Berrington & Bhandari, 2011). It is important for entities to know when to recognize provisions. The standard specifies when provisions have to be recognized so that a business should not be caught late with an obligation that has not had provisions. The stipulation for measurement of provisions is important to provide accountants with a guideline on how much to set aside for the provision. Provisions are measured or ascertained at the best estimate of the expenditure that is needed to settle the current obligation at the reporting date including any considerations for uncertainties and risks, and time value of money but excluding any tax consequences. Gains obtained from the expected disposal of assets are not taken into account in the measurement of a provision. It is stipulated that provisions have to be reviewed at every reporting date and adjusted to reflect the prevailing best estimate. The provision has to be reversed where it is no longer likely that an outflow of resources embodying economic benefits will be needed to settle the obligation (Kieso, Weygandt & Warfield, 2010). It should be noted that a provision is only used for expenditures for which the provision was originally recognized. Provisions for bad debts for bad debts cannot be used for provisions for depreciation and vice versa. There are limitations that have been raised in AASB 137. A provision shall not be recognized only for future operating losses. If a business entity has a contract which is onerous, the current obligation under the contract is usually recognized as a provision. Provision for restructuring costs has only to be recognized if the present obligation requirements are satisfied (Sandretto, 2011). The benchmark for measurement and recognition of provisions, contingent assets and contingent liabilities makes it easier for preparation of final accounts by accountants without causing confusion. AASB 137 also provides guidelines for recognition and measurement of contingent liabilities and assets. A contingent asset is a possible asset arising from past events and whose existence can only be confirmed by the non-occurrence or occurrence of one or more uncertain future events that are not within the control of the business entity (Collings, 2012). Contingent liabilities are not recognized as liabilities because either: (a) possible obligations, as it has not been confirmed whether the entity has a present obligation that would result in an outflow of resources embodying economic benefit; or (b) present obligations fall short of meeting the recognition criteria in the standard. AASB 137 has set the criteria for recognition and measurement of contingent assets and liabilities as well as provisions. These guidelines assist the accountants not to hurry in the recognition of an asset or a liability which is contingent. To recognize an asset that there is surrounding uncertainty about it would be misleading for the business entity. Likewise, the contingent liability makes it possible for funds to be set aside for settlement of the contingent liability when it finally translates to a liability. Without AASB 137, there would a lot of confusion in recognition of liabilities and assets as well as provisions. The business entity has to deal with its present, past and future and the AASB 137 is an ideal standard set out a roadmap for this accomplishment. The guidelines in AASB 137 address crucial issues which other accountant provisions have not adequately addressed. Contingencies and provisions make it possible for the business entity to address uncertainties and probable events that have an impact of changing the financial position of the entity. It is important and crucial for the business entity to recognize the liabilities and assets whose occurrence or non-occurrence is not within the domain of its power (Chand, 2011). If such obligations are overlooked and eventually they happen, there may not be enough liquid cash to address them. Business entities have to prepare for the future and recognize the importance of the past in the business dealings. It is better to have provisions in recognition of a probable expenditure than to ignore and cripple the performance of the business entity in future. AASB 137 has done a lot to ensure accurate reporting on the financial position of the company. This is important for both shareholders and prospective investors who would like to invest in the company. Conclusion Business entities have to evaluate their performance after a certain period in order to revise strategies and budget for the future. Financial reporting is the best way that business looks at its performance by assess its profits, financial positions and cash flow into and out of the business. To facilitate accurate reporting, AASB 137 provides important guideline for recognition and measurement of contingencies and provisions. It will be misleading to overlook provisions and contingent liabilities and contingent assets since they affect the financial position and profitability of the company. Rules and regulation stipulated in the Standard are crucial for business entities if they want to give a clear picture of the performance and position of the business entity. The exceptions to the standard are important to financial reporting because they specify what to include and what leave out when it comes to contingent liabilities and assets as well as provisions. Investors have a clear picture of the financial position of the business entity when provisions and contingencies are considered. References Berrington, M. & Bhandari, V., 2011, Pinnacle Financial Statements, Volume 2, IFRS SYSTEM, New Jersey. Bragg, S.M., 2010, IFRS Made Easy, John Wiley & Sons, London. Chand, P., 2011, Achieving global convergence of financial reporting standards, Emerald Group Publishing, Melbourne. Collings, S., 2012, IFRS for Dummies, John Wiley & Sons, London. Kieso, D.E., Weygandt, J.J. & Warfield, T.D., 2010, Intermediate Accounting: IFRS Edition, Volume 1, John Wiley & Sons, New York. Sandretto, M.J., 2011, Cases in Financial Reporting, Cengage Learning, New York. Read More