Explain the reason for creation of provision, how they are accounted for, and where it is presented in the funancial statement.
The primary reason for creating provisions is to account for and recognize certain liabilities or potential expenses that are uncertain in nature, but are likely to occur in the future. Provisions are made in order to ensure that financial statements provide a realistic and accurate representation of a company's financial position and performance.
Provisions are accounted for following the Generally Accepted Accounting Principles (GAAP). The process involves estimating the amount of the liability or expense, based on the best available information at the time. This estimation is typically done by considering historical data, expert opinions, and any other relevant factors. The estimated amount is then recognized as an expense on the income statement, and as a liability on the balance sheet.
In financial statements, provisions are presented separately from other liabilities and expenses to ensure transparency and clarity. They are usually listed under the liabilities section of the balance sheet, as a current or non-current liability, depending on the timing of the anticipated obligation. On the income statement, provisions are generally included within the operating expenses or categorized separately as "Provisions for [specific purpose]".
It is important to note that provisions are reviewed and adjusted regularly to reflect any changes in circumstances or new information. If the actual liability or expense incurred differs from the initial estimation, the provision is adjusted accordingly in subsequent financial statements. This ensures that the financial statements continue to reflect a reliable and accurate picture of the company's financial position.