What is PROVISIONS ? Meaning and Importance [2022]

What is PROVISIONS ?

According to the Companies Act the term following amounts :

“Provision’ refers to any of the

(a) The amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets; or

(b) The amount retained by way of providing for any known liability of which the amount cannot be determined with substantial accuracy. be

It should be clearly understood that if the amount of a known liability can determined with reasonable accuracy, it must be classified as an outright liability and not a provision. Also if any excess provision is made knowingly or amount in excess of the actual need will be treated as ‘reserve’.

intentionally, the

Examples of Provisions : Provisions are created for the fulfilment of various objectives : 1. Provision for Depreciation of Assets. 2. Provision for Taxation. 3. Provision for Bad and Doubtful Debts. 4.Provision for Discount on Debtors. 5. Provision for Repairs and Renewals of assets.

Characteristics or Features of Provisions :

(1) Provision is made to meet a known liability.

(2) The liability is known but the amount of such liability cannot be determined with reasonable accuracy. For example, it is almost certain that some debts will prove irrecoverable but the exact amount of bad-debts cannot be predicted with certainty. (3) Provision is a charge against profits and as such reduces the profits of the year in which it is created. The loss when actually occurs will be written off against such provision and thus the profit of the year in which such loss occurs will not be affected.

Purpose or importance of Provisions :

(1) To ascertain the true net profit of the business :- In order to ascertain the true profit of a business it is necessary that all expenses pertaining to that year, whether paid or outstanding, must be debited to Profit and Loss account and a provision should also be made for expenses or liabilities the amount of which cannot be estimated with reasonable accuracy. For example, the provision should be made for doubtful debts, because the amount of such bad-debts cannot be estimated very accurately.

(2) To ascertain the true financial position of the business The Balance Sheet will depict the true and fair view of the financial position of the business only if adequate provision is made for all the anticipated losses and expenses.

(3) To provide for known losses in the future :- Funds will be required to meet the losses and liabilities that are likely to occur in the near future. As such, provisions are made to provide funds for meeting those losses such as provision for taxation, provision for repairs, provision for damages likely to arise from a pending suit and such others.

(4) For the equitable distribution of expenses : – For example, if a machine is estimated to run for 10 years and the total amount of repairs expected to be incurred during its entire life span is 10,000, a ‘provision for repairs a/c’ will be created by debiting 31,000 to each year’s Profit & Loss Account. Actual expenses of repairs incurred each year will be debited to this account. Hence, it will put equal burden on the Profit & Loss Account of each year in respect of expenses of repairs which will be very light in the earlier years but definitely heavy in the later years.

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