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Declining car prices

17 September 2000
Issue: 3775 / Categories:
We are concerned with the basis of a United Kingdom motor car distributor's accounts and computations submitted by our predecessor. The Revenue has never challenged those relating to earlier accounting periods. The hitherto long established family partnership business became incorporated on 1 October 1997. Throughout, the client has considered the United Kingdom market over-priced and operated a continuous provision of 20 per cent to net down closing stock to its deemed realisable value, commandable upon an inevitable price collapse.
We are concerned with the basis of a United Kingdom motor car distributor's accounts and computations submitted by our predecessor. The Revenue has never challenged those relating to earlier accounting periods. The hitherto long established family partnership business became incorporated on 1 October 1997. Throughout, the client has considered the United Kingdom market over-priced and operated a continuous provision of 20 per cent to net down closing stock to its deemed realisable value, commandable upon an inevitable price collapse. Regarding the first company accounts to 31 December 1998, the Deputy District Inspector seeks to disallow the provision as not complying with accounting standards. The directors insist that, in order to reflect a consistently compatible true and fair view of the business's state of affairs, with ever-increasing evidence of imminent Government-directed price reduction, the provision should stand day-by-day until that happening, despite higher level realisation of much of the stock before they approved the accounts. They also cite many of their major competitors as having utilised similar such provisions. Is it considered that:

(1) The Inspector is correct, subject to a possible deferment of adjustment of what amounts to a contingent provision until the following year, being that relevant to the introduction of Financial Reporting Standard 12 in replacement of Statement of Standard Accounting Practice 18?
(2) Beyond contention is the interpretation that SSAP 9 permits the making of a contingent provision of this nature, which, thus attaching specifically to stock, cannot be over-ridden by SSAP 18 (Now FRS 12), which does not so attach?
(3) Omission of the provision does not contravene the Companies Act?

The observations of readers would be greatly appreciated.
(Query T15,679) Prudence.

Answers:
Financial Reporting Standard 12 is not relevant here. A 'provision' (in terms of FRS 12) is where an entity has a present obligation (as a result of a past event) to transfer economic benefits, where a reliable estimate can be made of the amount to settle the obligation.A provision against stock is not a legal or constructive obligation to transfer economic benefits, hence FRS 12 should be disregarded.

(1) It is not necessarily considered that the Inspector is correct. Statement of Standard Accounting Practice 9 states that stock should be valued at the total of the lower of cost and net realisable value of the separate items of stock or of groups of similar items. At the moment it does, however, appear that a 20 per cent provision across the board on a year on year basis does not accord with SSAP 9.
What the directors need to show is that the stock is effectively one group of items which will all be subject to the same market conditions and that it is likely that the realisable value of the stock will decline by 20 per cent on Government intervention which is likely to be very soon.
When valuing stock at the balance sheet date, the directors need to look at the period from the balance sheet to the date of approval of the accounts to see whether there is any evidence that supports valuations at the balance sheet date. Accordingly, any cars sold in this period will need to be adjusted to the lower of cost and selling price.
(2) SSAP 9 does permit the making of a provision subject to (1) above. FRS 12 is not relevant.
(3) Omission of the provision may contravene the Companies Act 1985. What is required here is an adjustment to the provision to bring it in line with Statement of Standard Accounting Practice 9.

In conclusion, 'Prudence' should attempt a compromise in this situation by readjusting the provision. -
Issue: 3775 / Categories:
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