`Big bath' time is running out

An abuse by which companies blur the distinction between good times and bad is finally to be ended.

Anybody who has ever spent any time following quoted companies will be familiar with the term "provisions". Sometimes, it seems as if nearly every organisation is providing or setting aside millions of pounds to cover eventualities such as restructuring or redundancies.

On the face of it, that looks like prudent housekeeping of the kind that should appeal to us all. However, as with all such policies, it is open to abuse.

And Sir David Tweedie and his colleagues at the Accounting Standards Board are convinced that that is exactly what has been happening for a good while. "All too often the provision is wildly excessive and conveniently finds its way back to the profit and loss account in a later period," Sir David, the ASB chairman, said last week.

As a result, the canny company is able to make a big provision when times are good and profits are running at an acceptable level and then claw some of the money back when things get a little tighter.

Having already moved to limit the discretion available to boards when providing for acquisitions, the board is proposing to end the abuse entirely by moving against provisions for a "big bath", where many different possibilities are thrown in together.

The plans were first published in 1995, to the somewhat predictable howls of protest from the corporate sector. Among directors' complaints was that the information that they would have to produce to justify provisions might be commercially sensitive. But although the board is apparently prepared to allow exceptions when disclosure of the justification of provisions in the run-up to a legal action might affect the company, it seems determined to press ahead with its reforms.

Under the rules which could be in place next year, provisions would be allowed only if the board is obliged to go ahead with expenditure on such matters as redundancies. It is a deliberate attempt to stop companies just saying that they intend to embark on a reorganisation and hence set aside an amount equivalent to the estimated cost of such an action.

"An entity is demonstrably committed when it has a detailed plan for, and cannot realistically withdraw from a reorganisation," the ASB says. It calls for provisions to be "realistic and prudent" and for each type of provision to be disclosed and measured, rather than just lumped together in the approach that led to the big baths that have so upset Sir David.

Under the proposals, provisions would not normally be allowed to cover future operating losses. However, those for enviromental liabilities should be shown in the balance sheet when the company is obliged - "legally or constructively" - to put right damage or restore the environment.

Gerry Acher, head of audit and accounting at KPMG, welcomed the extension of the original proposals, to include contingencies, on the grounds that "the two clearly overlap to a large extent".

He could also see the point of the board's simultaneous publication of proposals aimed at ensuring that companies show fixed assets in their balance sheets at no more than their "recoverable" value. The introduction of an impairment test in this area - under which, in Sir David's words, "assets that are genuinely impaired are written down" - fits in with the board's plans for the treatment of goodwill. This often tricky concoction is designed to account for the difference between the value of a company's assets and the price paid for the organisation in a takeover. It will soon be subject to its own impairment test with the aim of ensuring that businesses seek to measure the value of intangible assets, such as brands and other intellectual property.

"Provisions and impairments are interlinked anyway," Acher says. "For example, a reorganisation may entail both asset write-downs and other costs to be incurred. So it is absolutely right for the ASB to table both Freds (Financial Reporting Exposure Drafts) together."

But he adds that he and his counterparts in other firms would have to scrutinise them carefully to ensure that "they are workable and to the point".

Moreover, the International Accounting Standards Committee, headed by Sir Bryan Carsberg, is also working on those issues, so there is an opportunity for Britain to lead the way towards worldwide harmonisation in what has frequently been a highly contentious field

Independent Partners; Do you need financial advice on your investments, pension or insurance? Book a free consultation with an independent Financial Adviser at VouchedFor.co.uk

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