Importance of Provisions
Importance
of Provisions
1. Provision is an amount set aside out of current earnings
considered necessary to provide for all losses that are expected to arise out
of transactions entered into, during the accounting period.
2. Provision is made to retain future operating performance
undisturbed by losses arising out of transactions of prior periods.
3. Provision is made following the Prudence Concept of accounting
which holds "provide for all anticipated expenses and losses but do not
provide for anticipated incomes. By making a provision, a part of the profits
and corresponding assets are retained, which otherwise could have been
distributed as profits.
4. Any loss or depletion in the value of an asset or any liability as
may not have been provided against income or profit would effectively erode the
capital of a business. Creation of Provisions is an attempt to maintain the
capital of business intact.
Thus, Provisions represent (a) maintenance of capital, (b) adjustment of
capital as is lost or eroded in the process of generation of revenue with
current revenue and (c) a shield where loss arising out of past transactions
does not affect result of future operations. The above discussion brings out
the point that current income or profit cannot be measured without creating
provisions. Provisions are accordingly, considered as a charge against revenue
or profits.
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