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　　I. The accounting problem

　　Before IAS37 provisions were recognized on the basis of prudence， little guidance was given on when a provision should be recognized and how it should be measured. This gave rise to inconsistencies， and also allowed profits to be manipulated.

　　Some problems are noted below：

　　(a) Provisions could be recognized on the basis of management intentions， rather than on any obligation to be entity;

　　(b) Several items could be combined into one large provision. There were known as ‘big bath’ provisions;

　　(c) A provision could be created for one purpose and then used for another;

　　(d) Poor disclosure made it difficult to assess the effect of provisions on reported profits. In particular， provisions could be created when profits were high and released when profits were low in order to smooth profits.

　　(1) Definitions

　　IAS 37 views a provision as a liability.

　　A provision is a liability of uncertainty timing or amount;

　　A liability is an obligation of an enterprise to transfer economic benefits as a result of past transactions or events.

　　Provision must be based on obligations， not management intentions.

　　(2) Under IAS37， a provision should be recognized：

　　a. When an enterprise has a present obligation;

　　b. It is probable that a transfer of economic benefits will be required to settle it;

　　c. A reliable estimate can be made of its amount; if a reasonable estimate cannot be made， then the nature of the provision and the uncertainties relating to the amount and timing of the cash flows should be disclosed.

　　A provision is made for something which will probably happen. It should be recognized when it is probable that a transfer of economic events will take place and when its amount can be estimated reliably.

　　(3) Contingent liabilities

　　Definition

　　The Standard defines a contingent liability as：

　　(a) A possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the enterprise; or

　　(b) A present obligation that arises from past events but is not recognized because：

　　(i) It is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or

　　(ii) The amount of the obligation cannot be measured with sufficient reliability.

　　As a rule of thumb， probable means more than 50% likely. If an obligation is probable， it is not a contingent liability – instead， a provision is needed.

　　Treatment of contingent liabilities

　　Contingent liabilities should not be recognized in financial statements but they should be disclosed. The required disclosures are：

　　(a) A brief description of the nature of the contingent liability;

　　(b) An estimate of its financial effect;

　　(c) An indication of the uncertainties that exist;

　　(d) The possibility of any reimbursement;

　　(4) Contingent assets

　　Definition

　　A possible asset that arises from the past events whose existence will be confirmed by the occurrence of one or more uncertain future events not wholly within the enterprise’s control.

　　A contingent asset must not be recognized. Only when the realization of the related economic benefits is virtually certain should recognition take place. At that point， the asset is no longer a contingent asset.

　　Disclosure： contingent assets

　　Contingent assets must only be disclosed in the notes if they are probable. In that case a brief description of the contingent asset should be provided along with an estimate of its likely financial effect.

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　　II. Specific application

　　1. Future operating losses

　　In the past， provisions were recognized for future operating losses on the grounds of prudence. However these should not be provided for the following reasons.

　　①They relate to future events;