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HMRC internal manual

Business Income Manual

Specific deductions: provisions: examples of the effect of GAAP

Prior to the introduction of FRS12 in 1998, there was no guidance in UK GAAP on the general principles underlying provisions. As a result many provisions which, prior to the introduction of FRS12, accorded with UK GAAP no longer do so. You may obtain a better appreciation of the effect of current GAAP by considering how its application would have impacted on the following cases which all predated the introduction of FRS12:

  • Herbert Smith v Honour [1999] 72TC130 - a provision was made equal to the undiscounted value of future rentals payable in respect of premises no longer used in the partnership. Under current GAAP, a provision in respect of future obligations under an onerous lease would still be recognised. However, where the effect is material, it would be necessary to discount the provision to reflect the present value of the future rentals.
  • Jenners (Edinburgh) Ltd v CIR (SpC166/98) - the directors completed a feasibility study during the accounting year to 31 January 1995 on the possibility of refurbishing the company’s store. The company did not sign a contract with builders for the refurbishment until April 1995, but reflected a provision in its accounts to 31 January 1995 for the full expected cost of the work. Such a provision would not be permitted under current GAAP since an obligation to undertake the work had not arisen at the reporting date. In addition, a provision would not be permitted in the accounts to 31 January 1996 for the expenditure still to be incurred in the following year. This is because the contract made with the builder April 1995 is an executory contract and so a liability does not arise until the work has been carried out.
  • Johnston v Britannia Airways Ltd [1994] 67TC99 (1994 STC763) - the company operated an airline fleet, some of which it owned and some of which it leased. By law aircraft in the fleet would not be able to operate unless certified to do so. A condition for certification was that their engines were overhauled after 17,000 hours of operation. The company accrued the estimated cost of repairs over the 17,000 flying hours. It was held by the Commissioners and High Court that this was acceptable for tax. Under current GAAP, this accounting treatment would not be acceptable for aircraft owned by the company since no ‘present obligation’ would exist until the repairs were made. This would be the case even if a contract to carry out the repairs had been signed, since such a contract would be an executory contract and would not create an obligation until the repairs were actually carried out. However, for those aircraft held under operating leases, to the extent that the lease terms required repairs to be made, a provision would be included for the expected cost of those repairs as the obligation to carry them out accrued.