Skip to content

ACCA Strategic Professional · Strategic Business Reporting (International) · Provisions, contingencies and events after the reporting period

Delta Group, a listed parent, is finalising its financial statements to 31 March 20X6. It operates in a country where a new law, enacted in February 20X6, requires oil companies to restore sites at the end of production. Delta's finance director proposes to recognise a provision of $12m for restoration costs of a site not yet drilled, but expected to be drilled in 20X7, so that profit can be smoothed by being lower this year and released next year. Which response is correct under IAS 37 and ethical principles?

The provision should be rejected. Restoration of an undrilled site has no past obligating event, so there is no present obligation under IAS 37, and creating it to smooth profits is earnings management that breaches the fundamental ethical principles of integrity and objectivity.

  1. AAccept the proposal because the new law creates a legal obligation for all future sites
  2. BAccept it because prudence permits provisions to be built up in good years
  3. CReject the provision because no past event has occurred for the undrilled site, and the intent to smooth profit breaches the accountant's duty of integrity and objectivityCorrect
  4. DReject the provision only because the amount exceeds materiality, but disclose it as a contingent liability

Explanation

An obligating event for restoration is the drilling that causes the damage, which has not yet occurred, so there is no present obligation and no provision for future operating costs. Creating a provision for smoothing is earnings management, contrary to integrity and objectivity. Option 1 relies on prudence, which does not permit general reserves.

Did you get it right without looking?

One question tells you little. A timed set on Provisions, contingencies and events after the reporting period shows your real accuracy, how long you take and where you lose marks.

Practise Provisions, contingencies and events after the reporting periodFree diagnostic mock

More Provisions, contingencies and events after the reporting period questions