PROVISIONS, RESERVES AND CONTINGENT ASSETS & LIABILITIES Finance

Transcription

1 PROVISIONS, RESERVES AND CONTINGENT ASSETS & LIABILITIES Finance Version 3 January 2015 Not protectively marked

2 Introduction This note covers the subjects of provisions, reserves and contingent assets and liabilities. It explains the distinctions between the three areas and also includes guidance on the associated accounting treatment and ledger entries required. It provides practical examples aimed at assisting Finance Teams to determine the correct accounting treatment when faced with similar scenarios. Should you wish to discuss any of the contents of this note or need assistance with any issue which you feel might fit into the scope of provisions, reserves or contingent assets and liabilities then please contact: Provisions and Contingent Assets & Liabilities Helen Slater helen.slater@plymouth.gov.uk Reserves, - Sam Bray Samantha.bray@plymouth.gov.uk Distinction between provisions and reserves when setting aside funds for the future It is important that finance teams understand the difference between a provision and a reserve. Both reserves and provisions are methods of setting resources aside (earmarking) an authority s funds to cover future expenditure but each is treated differently in the accounts. When it comes to dealing with future liabilities, there can be a tension between the requirements for financial reporting incorporated in the Code and how, from a budgetary perspective, management might wish to spread the burden across financial years, as can be demonstrated by reviewing the distinction between the two:- a) A provision is compulsory as it is an accounting standards requirement. Provisions are charged as an expense to the appropriate service revenue account in the year that we become aware of the obligation. Provisions are required for any liabilities of uncertain timing or amount that have been incurred, and evidence that the liability exists is required. The settlement of the liability is made direct from the provision account. Provisions should be reviewed on a regular basis and revised as appropriate. This should be undertaken as a minimum annually as at 31 March to get an accurate position for the annual accounts. b) A reserve is voluntary, i.e. the authority chooses to set resources aside on the balance sheet. No expenditure is recognised in the service s revenue account until the year it is incurred. In Plymouth City Council, Cabinet approval is required for any reserve (with some exceptions, e.g. trading account surplus, school s balances). The associated expenditure is charged direct to the service revenue account when it is incurred (with a transfer from the earmarked reserve to effectively fund the spend). Further details in relation to this are shown in the table at Appendix A. So, the major point of difference is therefore the timing of the charge against service outturn. The accounting rules therefore allow no flexibility for authorities to provide for irregular but recurring material expenditure in order to smooth charges to services, no matter whether this might be a stated aim of budgetary arrangements. The next three sections of this document look, in a bit more detail, at provisions, reserves and contingent assets and liabilities, providing guidance on accounting treatment, ledger entries and Statement of Account disclosures. PROVISIONS, RESERVES AND CONTINGENT ASSETS & LIABILITIES Page 2 of 9

3 Provisions When should a provision be established? The IFRS Code (within section 8.2) is prescriptive about when provisions are required and when they are not permitted. Further guidance on this can be found within Module 8 of the Practitioners Guidance to the Code. The relevant international financial reporting standard (IFRS) which covers provisions is IAS 37 Provisions, Contingent Liabilities and Contingent Assets. A provision can only be established in the accounts if it meets the following criteria: the local authority has a present obligation (legal or constructive) as a result of a past event it is probable that a transfer of economic benefits (i.e. a payment) will be required to settle the obligation, and a reliable estimate can be made of the amount of the obligation A transfer of economic benefits or other event is regarded as probable if the event is more likely than not to occur. If these conditions are not met, a provision must not be recognised in the financial statements, although a disclosure via a contingent liability may be required (see page 8 for further guidance). The table below provides some examples of when a provision should be recognised: Issue Treatment Explanation Not a provision earmarked reserve possible Commitment of budget savings to employ new staff in next financial year Maintenance backlog for office accommodation Insurance claim for industrial accident that happened in the current year- legal advice suggests the authority is culpable Catering unit to be disbanded in next financial year, with redundancies. Relevant employees informed before end of year Essential costs of correcting known bugs in the housing benefit system Authority brings the administration of housing benefit back in house, although the contract with the private sector provider has 2 year to run. However it would cost the Not a provision earmarked reserve possible Provision Provision Not a provision earmarked reserve possible Provision onerous contract The policy may have been made public and a contract of employment concluded, but there will be no obligation to make payments until the employee starts to provide services under the contract It would be prudent for the authority to make good the backlog, but it is not obliged to do so and could continue to allow property to run down It is more probable than not that the authority will have to pay compensation, the obliging event being its negligence in allowing the accident to happen. If it becomes less likely that the claim will succeed, the provision would be removed and the claim would become a contingent liability. Decision to make redundancies is not sufficient to create a constructive obligation, but communication of the decision to involved parties creates a valid expectation that closure will take place and redundancy settlements will be forthcoming The authority has a legal obligation to pay benefits in accordance with statutory requirements, but is not obliged to do this by automation. It could continue to use system as it is and manually correct effects of bugs The obligating event is the entry into the contract, but there is no transfer of economic benefits due until the contract becomes onerous- this happens on the date that the authority decides to stop receiving services PROVISIONS, RESERVES AND CONTINGENT ASSETS & LIABILITIES Page 3 of 9

4 authority more in compensation to cancel the contract than it would to continue paying the minimum payments due under the contract s remaining term. Finance Teams should consult with Corporate Accountants before setting up any new provisions should that be necessary. Ledger entries for Provisions Journals to provisions accounts should be made using the following detail codes: Dr Revenue Account XXXX 5807 Cr Provision Account XXXX 0109 Transfers back from a provision should be as follows: Dr Provision Account XXXX 0109 Cr Revenue Account XXXX 5807 (reversing previous expenditure entry) Journals should be undertaken in line with the Corporate Journal Working Practice, which will include attaching appropriate evidence to the journal in the GL to substantiate both the reason for the provision and the value of the amount being set aside. In addition, it is imperative that the correct detail codes are used when posting the journals to enable the Statement of Accounts disclosure note relating to Provisions to be produced direct from GL and any period 16 statutory entries to be automated. Monitoring of Provisions Provisions should be reviewed on at least a quarterly basis during the year, with a final review undertaken at the year end as part of the process to finalise the outturn position on revenue accounts. The value remaining in any provision at 31 March needs to be substantiated, i.e. there needs to be evidence to justify why the provision is being held and calculations, where appropriate, which back up the amount carried. In addition, decisions on changes to provisions may be made by management as a corporate health adjustment where deemed appropriate. If you are unable to provide the necessary evidence you must consider whether the provision is required at all or needs to be reclassified, e.g. to a reserve. Once the uncertainty of the amount is removed, the provision should be reclassified as a creditor in the financial statements. Statement of Accounts disclosure re Provisions There is a requirement to publish information about provisions held by the authority in the annual Statement of Accounts. This includes both an analysis of the movement in provision balances during the year and the length of time we expect to hold the provision. The following information is required within the disclosure: a) The nature of the provision; b) A brief description; c) A prudent estimate of its financial effect; d) An indication of the uncertainties relative to the amount and/or timing. Under IFRS, a distinction needs to be made between those likely to be settled in the short term i.e. within 12 months (or, in balance sheet terms, current ) and those likely to be longer term (or non current ). The majority of the figures for the disclosure note are obtained direct from ledger. PROVISIONS, RESERVES AND CONTINGENT ASSETS & LIABILITIES Page 4 of 9

5 However, Finance teams are asked to provide some information for the note such as the reason why the provision is held and a breakdown between the short and long term elements of the provision balance. As well as the disclosures required under the main Provisions note, there may be the need to add references into the Assumptions Made About the Future and Other Major Sources of Estimation Uncertainty note as it is likely certain assumptions will have been made in assessing provision values. Audit Working Papers re Provisions All obligations under a provision must be able to be appropriately evidenced for audit purposes. The list of working papers that the auditor will review during the audit of the accounts include:- Analysis of provisions (opening balance, new provisions, provisions utilised, provisions released, closing balance) Itemised analysis of the calculation of the gross provision for all new provisions, including independent supporting evidence where available Details of expected timing of cash-flows resulting from the provisions Finance Teams are asked to provide the audit evidence as part of their work to close the revenue accounts. Allowance for the uncollectability of debts (previously called bad debt provision) The following section provides guidance in relation to the amount that is set aside in the accounts for debts that we don t expect to collect. Although not strictly a provision, the amount set aside for the uncollectability of debt is one that needs to be estimated using a similar methodology as used for Provisions. This is done by assessing the level of income that has been raised via invoices and thus included in service revenue accounts, but which has not actually been received at the end of the year. In order to access the level of this allowance finance teams should not only have regard to the age of debt outstanding but other factors as listed below:- significant financial difficulty of the debtor a breach of contract, i.e. non payment by due date where a debtor is granted a concession due to their financial difficulty that would not otherwise be considered (e.g. instalment facilities, extended payment periods) it becoming probable that the debtor will enter bankruptcy, receivership, etc. or is experiencing significant financial difficulty, disputes over legality of debt which are unlikely to be resolved in the Council s favour due to time lag or inability to provide evidence supporting the debt. adverse changes in the payment pattern of debtors (e.g. an increased number of delayed payments), or national or local economic conditions (e.g. a significant increase in the unemployment rate in the authority area); particularly relevant for commercial rental income In general where such factors exist a 100% provision will be required regardless of the age of the debt. Finance teams will have to justify the level of any allowance for the uncollectability of debts and working papers will be required for audit purposes. Working papers should outline any assumptions made on collectability. Both short and long term debtors should be reviewed and adjusted for any potential uncollectability. PROVISIONS, RESERVES AND CONTINGENT ASSETS & LIABILITIES Page 5 of 9

6 There are various factors that need to be taken into account when determining what the level of the provision for uncollectable debt should be, but a key requirement is that debts must be considered both individually (if significant) and collectively for impairment. It is important to note that impairment can only be based on historical evidence. Expected losses as a result of future events, no matter how likely, should not be recognised. For example, the downgrading of a credit rating of a debtor is not itself objective evidence of impairment, although it may be when considered with other information. When evaluating debts collectively for impairment, they should be grouped on the basis of similar credit risk characteristics. Factors to consider would normally include the type of debt (e.g. business rate debtors, commercial rent debtors and unsecured loans might be separate types) and age analysis of the debts. When determining the likely level of any future payments, consideration should be given to the historical pattern of payments, but making adjustments where current conditions indicate a different pattern might be expected. Corporate accountants will continue to review all debts corporately to ensure the provision is adequate, but any shortfall may be recharged to relevant departments and be reported as part of departmental outturn. It is therefore essential that service teams carefully consider the provision required. The ledger entries to top-up any allowance for the uncollectability of debts accounts at the yearend are as follows:- DR Revenue Account XXXX 5805 CR Bad Debt Provision XXXX 0064 These entries should be reversed where it is established that the allowance held at the year-end exceeds the estimate for the uncollectability of debts accounts at the year-end. Reserves The authority holds a number of earmarked reserves for various purposes, including:- Trading Account Retained Profits Statutory Ringfenced Reserves Commuted Maintenance Education/Schools Earmarked Reserves Amounts Earmarked for policy/future liabilities These reserves are additional to the authority s General Fund working balance. Reserves may not be set aside without a policy decision or Cabinet approval. Finance Teams should always consult with Corporate Accountancy before setting up a new reserve. Appendix A sets out the timing of reserve transactions; explaining that the charge to the service revenue account happens at the point the funds are expended and not when the funds are set aside into the reserve. In the main, transfers to and from reserves are budgeted for within the Corporate Items budget, even though they might effectively be funding expenditure in the service accounts. It is usual practice for revenue budgets to be increased where there is approval to fund expenditure from an PROVISIONS, RESERVES AND CONTINGENT ASSETS & LIABILITIES Page 6 of 9

7 earmarked reserve (e.g. ring-fenced revenue grant carried forward from one year to the next). Corporate Accountants will usually process any virements in relation to these approvals. There are, however, a few historical budgets where an annual contribution to an earmarked reserve is built in (e.g. annual contribution to the Foreshore Renewal Fund). Transfers to / from reserves should not be undertaken within the revenue accounts EXCEPT where budgeted for. Should this be applicable, Corporate Accountants need to be informed of transfers direct to / from reserves so adjustments can be undertaken in period 16 when producing the Statement of Accounts. This is because, for statutory account purposes, direct transfers between the service revenue accounts and the reserves are not permitted. Ledger entries for Reserves The following subjectives should be used to post transfers to / from reserves WHERE BUDGETED ONLY:- Revenue codes Reserve codes transfer to reserves transfer from reserves In all other cases, transfers to / from reserves should only be made by Corporate Accountants via revenue account 4836 (Transfer to / from earmarked reserves) as follows:- Transfer to reserve:- DR CR XXXX 0085 (Where XXXX is the balance sheet reserve account) Transfer from reserve:- DR XXXX 0086 (Where XXXX is the balance sheet reserve account) CR Please contact Sam Bray Samantha.bray@plymouth.gov.uk should you require any advice on ledger entries re reserves. Monitoring of Reserves As for Provisions, Reserves need to be monitored and reviewed on a regular basis as part of the Corporate Monitoring process. The review should include an assessment that the reserve is still required. In order to produce the outturn report we will also need an estimate of the movement over the next 3 years. Statement of Accounts disclosure re Reserves Details of all movements of reserves are required in the notes to the accounts. In the main, we have moved to disclosing the Reserves under themes rather than reporting every reserve separately. This has been done to reduce the size of the note as we endeavour to reduce the overall length of the document. Further details on the reserves may be obtained by the public within the Outturn report to Cabinet so there is no added value by repeating the same information within the Statement of Accounts. The majority of information required for disclosure can be obtained straight from the ledger, providing the correct detail codes have been used. However, service teams are requested to give a full explanation of the purpose of the reserve and may need to be contacted to discuss individual transfers where necessary. PROVISIONS, RESERVES AND CONTINGENT ASSETS & LIABILITIES Page 7 of 9

8 Audit Working Papers re Reserves The audit working paper requirements in relation to Reserves are as follows:- For any discretionary/earmarked (other) reserves, statement of purpose and copy of authorisation for their utilisation Contingent Assets and Liabilities The following section provides guidance on contingent assets and liabilities including providing examples of issues that might fall into each category. Although these issues do not give rise to entries within the accounts, they do, however form part of the disclosures we have to make within the Statement of Accounts and, more importantly, help inform management of potential financial opportunities or risks that may arise in the future. What is a Contingent Asset? A contingent asset arises where an event has taken place that gives the authority a possible asset whose existence will only be confirmed by the occurrence or otherwise of uncertain future events not wholly within the control of the authority. Contingent assets are not recognised in the balance sheet but disclosed in a note to the accounts where it is probable that there will be an inflow of economic benefits or service potential. Possible contingent assets include:- An anticipated reimbursement of tax following a challenge to HMRC Potential capital receipts which may arise under certain circumstances yet to be confirmed What is a Contingent Liability? A contingent liability arises where an event has taken place that gives the authority a possible obligation whose existence will only be confirmed by the occurrence or otherwise of uncertain future events not wholly within the control of the authority. Contingent liabilities also arise in circumstances where a provision would otherwise be made but either it is not probable that an outflow of resources will be required or the amount of the obligation cannot be measured reliably. Contingent liabilities are not recognised in the Balance Sheet (no entries or expenditure is made in the accounts) but disclosed in a narrative note in the accounts. Possible contingent liabilities include:- Legal claims pending settlement where there is no clear precedent Contractual claims pending Provision of warranties for future events e.g. environmental warranties for transferred land Possible future claims for reimbursements of income collected where (national) court cases indicate income was not legally payable by service recipient PROVISIONS, RESERVES AND CONTINGENT ASSETS & LIABILITIES Page 8 of 9

9 The table below explains the contrasts between provisions and earmarked reserves. APPENDIX A Status Timing Setting up balance sheet entry Managing the balance Financing eventual payment Earmarked Reserve Provision Voluntary- authority Compulsory the code chooses to set resources requires provision to be aside on the balance sheet made as a liability has been established When authority determines At point liability arises Debit made as an Debit made to service appropriation via the revenue account as Movement in Reserves expenditure and therefore Statement (MiRS) (not the included as part of the service revenue account) outturn of the relevant Debits and credits at discretion of authority Expenditure is debited to service revenue account when liability is eventually taken on and is then included in the outturn of the relevant service. The reserve is appropriated back to General Fund in the Movement in Reserves Statement (MiRS) 1. service Balance will only move as the underlying liability changes, either because the estimated settlement of the liability changes or because settlement has been made. Settlement of the liability is debited directly to the provision in the balance sheet. 1 In practice, service expenditure budgets are increased for carry forward spend and the transfer from reserve to fund the spend is held within the corporate items budget PROVISIONS, RESERVES AND CONTINGENT ASSETS & LIABILITIES Page 9 of 9