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Corporate Financial Accounting - Essay Example

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Prior to the issuance of IAS 37, provisions were recognised on the basis of the prudence concept. There was almost no guidance on the proper treatment of a provision in the financial statements and because…
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Corporate Financial Accounting
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Corporate Financial Accounting

Download file to see previous pages... management would create a provision for restructuring without having any commitment. Besides this, management used to manipulate the auditors by combining in many little amounts of provisions, which, when gathered made up a huge amount. This helped them to skim their profits and gain tax advantages, etc. Except these two problems, provision accounting used methods where provision was created for one purpose and then used for another. All this led to poor disclosure and difficulty in assessing the effect of provisions on reported profits.
Provisions were particularly created when profits were high and decreased or eliminated when profits were low in order to smooth the outcome. This was commonly done when an organisation acquired another business entity, the acquirer created increased number of provisions as a cost of merging the new business’s operations. When the provisions were released later, the profits reported would seem falsely inflated.
Provision accounting was used to boost share price by disguising poor performance in a particular year by profit smoothing to create an impression that the profit are less volatile, this led to increased investing in a particular company. (Management Accountant Blog, 2007)
To overcome such an issue, the International Accounting Standards Board (IASB) came up with International Accounting Standard (IAS 37). This standard’s main purpose was to prevent organisations from recognising excessive provisions by focusing on the Balance Sheet and applying proper definition and recognition criteria in the framework for the preparation and presentation of financial statements. According to IAS 37 can only be recognised if it meets the criteria of a liability and a liability according to IAS 37 is “a present obligation arising from past events, the settlement of which is expected to result in an outflow ...Download file to see next pagesRead More
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