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As we all have known depreciation & doubtful debts are to be provided as a provision in the accounts of an entity, it contradicts with IAS 37 definition of a provision.
IAS 37 states
All provisions are liabilities,and to be a provision it should satisfy three requirements as to
1.It being a obligation by the entity.
2.A reliable estimate could be made of the obligation.
3. It will result in an outflow of resources when settled.So given the definitions of a provision how could depreciation & doubtful debts be provided as an provision.Both are not liabilties for an entity and does not satisfy all three requirements mentioned as in IAS 37 to be called as a provision.Consider these examples:
1. If all debtors for an example where found to be irrecoverable and were treated as bad debts,it will be written off as an EXPENSE in the accounts in the relevant financial year, but if say, 20% were found to be doubtful debts how can we categorize that as a LIABILITY(given that all provisions are liabilities)?.
2. How could depreciation charged against profits be an liability? How does an obligation arise through the usage of an asset? shouldn’t it be treated as an allowance to show the relevant usage of the asset in the given financial year?
So shouldn’t IAS 37 be revised and Depreciation and doubtful debts be treated as an- Allowance/usage cost for the year rather than terming it as a provision?
“Provisions” for depreciation and doubtful debts were around long before IAS 37 turned up so its probably more the terminology of those that needs revised because neither of them qualify as a provision under IAS 37.
Under IAS 37, to qualify as a provision, the first test is that it has to be a present obligation as a result of a past event.
Depreciation fails to meet that because depreciation is to conform to the accruals concept in an attempt to spread the cost of the asset across the same number of periods that revenue is generated by it.
The provision for doubtful debts stems from the now defunct Prudence concept (I say defunct because Prudence is no longer recognised as a concept in its own right, but is embedded across the standards instead). The theory behind it was that if you’re selling stuff on credit, then it’s likely that some debtors will default and so it was an attempt to estimate that and provide a more accurate record of what you expected to get back. But it fails the IAS 37 test as well, because estimating the amount of debts that might not be repaid is looking to the future so isn’t a present obligation as a result of a past event.
Besides, receivables fall under the remit of IAS 39 now, so a general provision for doubtful debts isn’t allowed. It’s only allowed in relation to specific debts where, for whatever reason, it has become known that they aren’t going to be paid, or paid in full.
There is an exposure draft to IFRS 9 on the go though that is looking at the “expected loss model” – which, in relation to receivables, sounds to me much the same as the old provision for doubtful debtors idea.
@saajidh
Provisions used to be a favourite way to manipulate performance and smooth income because of the flimsy principles.
The new standard IAS 37 has solved many of these problems.
As you correctly mentioned all provisions are liabilities of uncertain timing or amount subject to a 3 point criteria. Provisions for bad debts and depreciation fail the criteria and are not the type of provisions mentioned in IAS 37.
They are contra accounts or adjustments to the carrying value of assets and are dealt with in other standards like
IAS 36, IAS 39 & IAS 16.
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