FRS 12 – Provisions, contingent liabilities and contingent assets was issued in September 1998.

Prior to its publication, there was no UK Accounting Standard that dealt with the general subject of accounting for provisions.

Extract plc prepares its financial statements to 31 December each year. During the years ended 31 December 2000 and 31 December 2001, the following event occurred:

Extract plc is involved in extracting minerals in a number of different countries. The process typically involves some contamination of the site from which the minerals are extracted. Extract plc makes good this contamination only where legally required to do so by legislation passed in the relevant country.

The company has been extracting minerals in Copperland since January 1998 and expects its site to produce output until 31 December 2005. On 23 December 2000, it came to the attention of the directors of Extract plc that the government of Copperland was virtually certain to pass legislation requiring the making good of mineral extraction sites. The legislation was duly passed on 15 March 2001. The directors of Extract plc estimate that the cost of making good the site in Copperland will be £2 million. This estimate is of the actual cash expenditure that will be incurred on 31 December 2005.

Required

(a) Explain why there was a need for an Accounting Standard dealing with provisions, and summarise the criteria that need to be satisfied before a provision is recognised.

(10 marks)

(b) Compute the effect of the estimated cost of making good the site on the financial statements of Extract plc for BOTH of the years ended 31 December 2000 and 2001. Give full explanations of the figures you compute.

The annual discount rate to be used in any relevant calculations is 10%. (10 marks)

CIMA, Financial Reporting – UK Accounting Standards, May 2001 (20 marks)