ACCA Strategic Professional · Strategic Business Reporting (International) · Professional and ethical behaviour in corporate reporting

Marlow Co has a policy of making large provisions in years of high profit and releasing them in years of low profit, so that reported profit rises smoothly each year. No provision breaches IAS 37 recognition criteria individually in the current year, but the prior-year provisions were not based on a present obligation. Which statement best describes this practice under IFRS Accounting Standards?

The practice is not permitted. IAS 37 allows provisions only for present obligations with a probable outflow and reliable estimate, so building and releasing cookie jar reserves to smooth profit is earnings management that undermines neutral, faithful representation, and disclosure or claimed prudence does not make it acceptable.

1. AAcceptable prudence, because overstating liabilities is always safer than understating them
2. BAcceptable if disclosed in the notes as income smoothing
3. CNot permitted, because provisions can only be recognised where there is a present obligation, a probable outflow and a reliable estimate, so 'cookie jar' reserves are earnings managementCorrect
4. DAcceptable because directors may choose the timing of provisions under IAS 1