Department of Health, Social Services & Public Safety An Roinn Slinte, Seirbhs Sisialta agus Sbhilteachta Poibl

HSS(F)18/2000

The Chief Executive/General Manager of each HSS body The Director of Finance of each HSS body 11 April 2000

Dear Sir/Madam

FRS 12 Provisions, Contingent Liabilities and Contingent Assets: Applicability to HSS bodies
This circular provides guidance to HSS bodies on the application of FRS 12 Provisions, Contingent Liabilities and Contingent Assets to their accounts. Introduction 1. The Accounting Standards Boards issued Financial Reporting Standard (FRS) 12: Provisions, Contingent Liabilities and Contingent Assets to apply to financial statements that are intended to give a true and fair view ending on or after 23 March 1999. FRS 12 supersedes SSAP 18 Accounting for Contingencies. FRS 12 is applicable to the accounts of HSS bodies from 1999/2000. 2. The purpose of this circular is to state the main requirements of FRS 12 and to describe how these should be applied to particular circumstances that may arise in the HPSS. The circular is not comprehensive for all possible provisions, contingent liabilities and contingent assets and HSS bodies should refer to FRS 12 for specific guidance if other items arise to which the FRS may apply.

3.

Summary of FRS 12 4. FRS 12 sets out the principles of accounting for provisions, contingent liabilities and contingent assets. The objective of FRS 12 is to ensure that appropriate recognition criteria and measurement bases are applied to provisions and contingencies and that appropriate disclosure is made in the accounts.

5.

The FRS states that a provision should only be recognised in the income and expenditure account where there is the certainty of a present obligation (legal or constructive) as a result of a past event and the amount of the obligation can be reliably estimated. If the liability arises from an event which is too uncertain or the amount of the obligation cannot be reliably estimated, the liability should not be provided for but should be disclosed as a contingent liability. A contingent asset will also arise from an event which is too uncertain and therefore should not be accounted for but disclosed as a note to the accounts. The definitions which apply in the FRS are set out in Annex A to this Circular.

6.

7. 8.

Application of FRS 12 9. FRS 12 will apply to the accounts of HSS bodies with effect from 1 April 1999. Previously HSS bodies were not permitted to make provisions in their accounts except in relation to early retirement costs as advised by circular HSS(F)10/96. Therefore the adoption of FRS 12 is a change in accounting policy. The FRS states that changes in accounting policy arising from the initial application of the FRS should be dealt with as a prior period adjustment in accordance with FRS 3. This means that if the application of FRS 12 results in the recognition of a provision for the first time then this should be dealt with as a prior period adjustment. Annex H to this circular sets out the guidance for accounting for prior period adjustments in accordance with FRS 3. However, where the application of FRS 12 merely results in an adjustment to the amount of a provision, the adjustment should be accounted for in the Income and Expenditure account for 1999/2000. Accounting by HSS bodies 10. The adoption of FRS 12 means that certain provisions which were previously not accounted for in the accounts of HSS bodies will now have to be recognised. The application of FRS 12 to particular issues in the accounts of HSS bodies is covered in the annexes to this circular as follows: clinical negligence restructurings early retirements repairs and maintenance other claims Annex B Annex C Annex D Annex E Annex F

The above are examples only and it is not intended to be an exhaustive list of all items to which FRS 12 is applicable. HSS bodies should refer to the recognition criteria to determine whether or not a provision should be made in particular circumstances. 11. 12. The changes to accounting and disclosure requirements under FRS 12 have been incorporated into the revised format of accounts of HSS bodies. Any enquiries regarding the content of this circular should be directed to Policy and Accounting Unit, Room 507 Dundonald House, telephone 520829.

Yours faithfully

PAULA A MAGEE Policy and Accounting Unit

ANNEX A MAIN REQUIREMENTS OF FRS 12 Definitions The following paragraphs have been adapted from the FRS. 1. The objective of FRS 12 is to ensure that appropriate recognition criteria and measurement bases are applied to provisions, contingent liabilities and contingent assets and that sufficient information is disclosed in the notes to the financial statements to enable users to understand their nature, timing and amount. FRS 12 provides the following definitions: A provision is a liability that is of uncertain timing or amount, to be settled by the transfer of economic benefits. (The term provision is also used sometimes in the context of items such as depreciation, impairment of assets and doubtful debts: these are adjustments to the carrying amounts of assets and are not addressed in FRS 12.) Provisions can be distinguished from other liabilities such as trade creditors and accruals because there is uncertainty about the timing or amount of the future expenditure required in settlement. Although it is sometimes necessary to estimate the amount or timing of accruals, the uncertainty is generally much less than for provisions. A contingent liability is either: a possible obligation arising from past events whose existence will be confirmed only by the occurrence of one or more uncertain future events not wholly within the entitys control; or a present obligation that arises from past events but is not recognised because: it is not probable that a transfer of economic benefits will be required to settle the obligation, or the amount of the obligation cannot be measured with sufficient reliability.

2. 2.1

2.2

In a general sense, all provisions are contingent because they are uncertain in timing or amount. However, in FRS 12 the term contingent is used only for liabilities and assets that are not recognised (ie not accounted for). 2.3 A contingent asset is a possible asset arising from past events whose existence will be confirmed only on the occurrence of one or more uncertain future events not wholly within the entitys control.

Accounting Requirements - Recognition 3. The following are the main accounting requirements of FRS 12. The wording is taken directly from the FRS so that no meaning is lost. As a result there are references to the Profit and Loss account rather than the Income and Expenditure account. Where another FRS or SSAP deals with a more specific type of provision, contingent liability or contingent asset, an entity applies that standard instead of FRS 12. For example certain types of provisions are addressed in standards on leases (SSAP 21) and long-term contracts (SSAP 9). FRS 12 requires that a provision should be recognised (ie accounted for): when an entity has a present obligation (legal or constructive) as a result of a past event; and it is probable that a transfer of economic benefits will be required to settle the obligation; and a reliable estimate can be made of the amount of the obligation.

4.

5.

Unless these conditions are met, no provision should be recognised. The FRS gives further guidance regarding these conditions as follows: 5.1 Present obligation. Where it is not clear whether a present obligation exists, a past event is deemed to give rise to a present obligation if, taking account of all available evidence, it is more likely than not that a present obligation exists at the balance sheet date. Past event. For an event to be an obligating event, it is necessary that the entity has no realistic alternative but to settle the obligation created by the event. This will be the case only where the settlement of the obligation can be enforced by law or, in the case of a constructive obligation, creates valid expectations in other parties that the entity will discharge the obligation. No provision is recognised for costs that need to be incurred to operate in the future. The only liabilities recognised in an entitys balance sheet are those that exist at the balance sheet date. Probable transfer of economic benefits. A transfer of economic benefits in settlement of an obligation is regarded as probable if the outflow is more likely than not to occur. Where there are a number of similar obligations, the probability that a transfer will be required in settlement is determined by considering the class of obligations as a whole. Although the likelihood of outflow for any one item may be small, it may well be probable that some transfer of economic benefits will be needed to settle the class of obligations as a whole. If that is the case a provision is recognised (if the other recognition criteria are met). Reliable estimate. An entity will normally be able to determine a range of possible outcomes and can therefore make an estimate of the obligation that is sufficiently reliable to use in recognising a provision. The amount recognised should be the best

5.2

5.3

5.4

estimate of the expenditure required to settle the present obligation at the balance sheet date and should take account of the risks and uncertainties that inevitably surround many events and circumstances. Where the effect of the time value of money is material, the amount of a provision should be the present value of the expenditures expected to be required to settle the obligation. In the extremely rare case where no reliable estimate can be made, a liability exists that cannot be recognised. That liability is therefore disclosed as a contingent liability. 6. The estimates of outcome and financial effect are determined by the judgement of the entitys management, supplemented by experience of similar transactions and, in some cases, reports from independent experts. The evidence considered will include any additional evidence provided by events after the balance sheet date. Where some or all of the expenditure required to settle a provision is expected to be reimbursed by another party, the reimbursement should be recognised only when it is virtually certain that reimbursement will be received if the entity settles the obligation. The reimbursement should be treated as a separate asset although in the profit and loss account the expense relating to a provision may be presented net of the amount recognised for a reimbursement. (Note - this does not apply to reimbursements for clinical negligence from the Central Fund). Provisions should be reviewed at each balance sheet date and adjusted to reflect the current best estimate. If it is no longer probable that a transfer of economic benefits will be required to settle the obligation, the provision should be reversed. Where discounting is used, the carrying amount of a provision increases in each period to reflect the passage of time. This change is recognised as a financial expense adjacent to interest but disclosed separately from other interest either on the face of the profit and loss account or in a note. An entity should not recognise (ie account for) a contingent liability. Contingent liabilities are assessed continually to determine whether a transfer of economic benefits has become probable and if so, a provision is recognised in the financial statements of the period in which the change in probability occurs. An entity should not recognise (ie account for) a contingent asset. Contingent assets are assessed continually and if it has become virtually certain that an inflow of economic benefits will arise, the asset and the related profit are recognised in the financial statements of the period in which the change occurs.

7.

8.

9.

10.

11.

Disclosure Requirements 12. 13. The following are the disclosure requirements of FRS 12. For each class of provision an entity should disclose: the carrying amount at the beginning and end of the period; additional provisions made in the period, including increases to existing provisions;

amounts used during the period; unused amounts reversed during the period; and the change in the discounted amount arising from the passage of time and the effect of any change in the discount rate.

Comparative information need not be disclosed for these items. 14. In addition, for each class of provision the entity should disclose the following: a brief description of the nature of the obligation, and the expected timing of any resulting outflows of the economic benefits; an indication of the uncertainties about the amount or timing of those outflows, including, where necessary to provide adequate information, the major assumptions made concerning future events; and the amount of any expected reimbursement, stating the amount of any asset that has been recognised for that expected reimbursement.

15.

Unless the possibility of any transfer in settlement is remote, for each class of contingent liability at the balance sheet date a brief description of the nature of the contingent liability should be disclosed and, where practicable: an estimate of its financial effect; an indication of the uncertainties relating to the amount or timing of any outflow; and the possibility of any reimbursement.

Where a provision and contingent liability arise from the same set of circumstances, an entity makes the disclosures required under paragraphs 12 14 above in a way that shows the link between the provision and the contingent liability. 16. Where an inflow of economic benefits is probable, the entity should give a brief description of the nature of the contingent assets at the balance sheet date and, where practicable, an estimate of their financial effect. Where any of the information required by this paragraph and paragraph 14 above is not disclosed because it is not practicable to do so, that fact should be stated. The FRS permits that in extremely rare cases, disclosure of some or all of the information required can be expected to prejudice seriously the position of the entity in a dispute with other parties on the subject matter of the provision, contingent liability or contingent asset. In such cases the information need not be disclosed; but the general nature of the dispute should be disclosed, together with the fact that, and reason why, the information has not been disclosed (this exemption may be of particular relevance in the area of clinical negligence).

17.

Initial application of FRS 12 18. FRS 12 states that: changes in accounting policy arising from the initial application of the FRS should be dealt with as prior period adjustments in accordance with FRS 3, and corrections of accounting estimates should be dealt with in the profit and loss account of the period of initial application and their effect stated where material.

Withdrawal of SSAP 18 19. The FRS supersedes SSAP 18 accounting for contingencies.

ANNEX B CLINICAL NEGLIGENCE CLAIMS Summary of Requirements under FRS 12 The main changes to the accounting requirement for clinical negligence claims are: all clinical negligence claims which fulfil the recognition criteria should be provided for; provisions should be calculated using the expected value concept, and discounted to present value if its effect is material; there will be gross accounting in the balance sheet for provisions and expected reimbursements from the Clinical Negligence Central Fund; where a reliable estimate can be made for Incurred But Not Reported (IBNR) cases, a provision should be made; there will be new disclosures relating to provisions, giving the expected timing of forecast payments and an indication of the associated uncertainties (if appropriate).

Accounting for Clinical Negligence Claims 1. 2. The current accounting policy in respect of clinical negligence claims is that HSS bodies accrue only clinical negligence claims settled by the balance sheet date. However FRS 12 requires that a provision should be recognised when an entity has a present obligation (legal or constructive) as a result of a past event and it is probable that a transfer of economic benefits will be required to settle the obligation and a reliable estimate can be made of the amount of the obligation. Clinical negligence claims will fulfil the above conditions to the extent that they are present obligations which are as a result of past events and it is probable that a transfer of economic benefits will be required to settle the obligation. The remaining condition to be fulfilled i.e. that a reliable estimate can be made of the amount of the obligation would indicate that clinical negligence claims should be recognised (provided for) when settlement is probable. FRS 12 states, where there are a number of similar obligations the probability that a transfer is required in settlement is determined by considering the class of obligations as a whole. Under this approach clinical negligence is regarded as one class and all incidents of clinical negligence should be provided for, unless the third recognition test is failed, that is, when a reliable estimate cannot be made. In practice, it should be possible to obtain a reliable estimate of all clinical negligence claims received (as opposed to incidents) by an HSS body and hence all claims should

3.

4.

5.

be provided for as and when they are received. Provisions should be calculated using the expected value concept (see below) which takes account of the probability of settlement. 6. Incurred but not reported (IBNR) cases may fulfil certain recognition criteria under FRS 12 in that there may be a present obligation as a result of a past event and it is probable that a transfer of economic benefits will be required to settle the obligation when clinical negligence is viewed as a class of obligations. If a reliable estimate can be made (the third test) a provision for IBNR should be made. This should be the case for known incidents where work has been undertaken to identify claims. However, all HSS bodies should work towards identifying the value of their IBNR cases, with a register of clinical incidents as the source of making an informed estimate of the liability.

Value of Provisions 7. FRS 12 states that: the amount recognised as a provision should be the best estimate of the expenditure required to settle the present obligation at the balance sheet date. The best estimate of the expenditure required to settle the present obligation is the amount that an entity would rationally pay to settle the obligation at the balance sheet date. The estimates of outcome and financial effect in relation to clinical negligence will be based on advice from legal advisers. Appendix 1 to this annex gives more detailed guidance on the calculation of provisions. The FRS further states that: where the provision being measured involves a large population of items, the obligation is estimated by weighting all possible outcomes by their associated probabilities. This is the expected value concept. This is the amount that takes account of all possible outcomes, using probabilities to weight the outcomes. 8. The FRS continues: where a single obligation is being measured, the individual most likely outcome may be the best estimate of the liability. However, even in such a case, the entity considers other possible outcomes. Where other possible outcomes are either mostly higher or mostly lower that the most likely outcome, the best estimate will be a higher or lower amount. 9. It is considered appropriate that HSS bodies should adopt the expected value concept for all clinical negligence claims. The forecast outcomes should include: all the elements making up the forecast settlements (loss of earnings, cost of care etc), the claimants legal costs; and

the defence legal costs.

HSS bodies must forecast the highest and lowest possible outcome for each claim and weigh these by their respective probabilities. Discounting 10. FRS 12 requires discounting of provisions where the effect of the time value of money is material. Quantifying materiality will depend on a range of factors eg the size of the provision relative to other items in the balance sheet, the impact of any adjustment on the profit for the year etc. Given the lapse of time that can occur between a claim and a settlement, this will generally be the case for clinical negligence claims. Discounting should be applied for whole years and unwinding of a discount should be carried out at the balance sheet date. It is therefore suggested that a claim which arises in the first half of the financial year should be discounted for that year whereas one that arises in the second half should not. Claims should be discounted at 6% per year. The discount factors over ten years are given in Annex G to this circular.

Unwinding of Discounts 11. When any item in the balance sheet is discounted (whether a provision or a debtor) there will be a subsequent increase in that item as time passes and the settlement date gets closer. This is the unwinding of the discount and under FRS 12, the unwinding of the discount must be shown as interest and will be disclosed separately in the interest payable note to the accounts. The provision will be increased by an equal amount. The interest charge resulting from the unwinding of the discount should be accounted for before any revision of the provision at the balance sheet date.

Structured Settlements 12. HSS bodies who have a self-funded structured settlement will have to account for the present value of the forecast cash flows as a provision. This figure should be available from your Value for Money Report on the structured settlement (HSS(F)21/98) Clinical Negligence and Claims: Structured Settlements refers). The discount on the outstanding provision must then be unwound at the end of each year, as appropriate. Appendix 1 to HSS(F)21/98 gives details of the VFM calculations.

Balance Sheet Review 13. Under FRS 12, clinical negligence provisions and any related reimbursements have to be reviewed each year as at the balance sheet date and adjusted to reflect the current best estimate. This may be in terms of estimated cash flows of change to the present value. Any provision no longer required must be reversed. Provisions and contingent liabilities for clinical negligence should be considered when identifying post balance sheet events. Generally accepted accounting practice should be followed (Statement of Standard Accounting Practice 17 refers).

14.

Contingent Liabilities 15. 16. There will be provisions for all claims which fulfil the recognition criteria under the above guidance. Where the definition of a provision is not met, the liability may come within the definition of a contingent liability. A contingent liability will arise in circumstances where: (i) (ii) (iii) there is a possible rather than a present obligation; or an outflow of economic benefits is not probable; or there is an inability to measure a probable outflow.

Unless the possibility of a settlement is remote, a contingent liability must be disclosed. The financial effect of a contingency should be estimated in accordance with Paragraphs 7-9 above. Disclosure 17. The disclosure requirements under FRS 12 are summarised in Annex A to this circular. However HSS bodies should note that the FRS permits non disclosure of some or all of the required information if the disclosure of that information would prejudice the position of an entity in a dispute with other parties on the subject matter of the provision. This may be particularly relevant to provisions in relation to clinical negligence claims particularly for smaller Trusts whose disclosure may relate to a single claim. HSS bodies should be careful not to disclose any information which may prejudice their position in claims. Accounting - Introduction of FRS 12 - Prior Year Figures 18. The adoption of FRS 12 in relation to accounting for clinical negligence claims represents a change in accounting policy. Therefore in accordance with the FRS this change in accounting policy should be dealt with as a prior period adjustment in accordance with FRS 3, and adjusted against the opening balance of retained reserves and the amounts for the current and corresponding periods restated on the basis of the new policy. (See also Annex H.) The calculations to be carried out on each claim at each balance sheet date and order in which they should be done are given in Appendix 1 to this Annex. A worked example is also shown.

19.

Accounting by HSS Bodies 20. HSS bodies will be required to account for all clinical negligence for which they are liable as appropriate. HSS bodies will also be required to account for any expected reimbursement from the Central Fund. Appendix 1 to this Annex contains guidance for HSS bodies on the approach to be adopted for 1999/2000 in estimating the total value of their clinical negligence provision.

21.

Appendix 1 1999/2000 ACCOUNTS PREPARATION ACCOUNTING GUIDANCE FOR PROVIDING FOR CLINICAL NEGLIGENCE LIABILITIES CONSISTENT WITH FRS 12 1. Introduction The following guidance is to be followed by HSS bodies in estimating the value of their provisions for clinical negligence claims for 1999/2000 and prior years as appropriate under FRS 12. It is imperative that all HSS bodies adhere to the guidance and dates as specified. 2. It is essential that all bodies adopt a consistent approach to the estimation of their claims and also it is vital that all required information is submitted to the Central Services Agency in accordance with a specific timetable so that the accounts preparation process can be completed in accordance with deadlines. It is recognised that the introduction of FRS 12 will have a significant impact on the workload of HSS bodies and their legal advisers, particularly in the first year of its application. Therefore the following paragraphs provide some practical guidance for HSS bodies in compliance with FRS 12. 3. Application FRS 12 Provisions, Contingent Liabilities and Contingent Assets to HSS Bodies The proposals below set out practical arrangements for HSS bodies for compliance with FRS 12. (a) For preparation of 1999/2000 Accounts it is necessary to calculate the clinical negligence provision for 3 financial year ends: 31 March 1998; 31 March 1999; 31 March 2000. (The calculation for 1998 and 1999 is necessary to calculate the prior year comparative charge to the Income and Expenditure Account for 1998/99). The provision calculation for each financial year end will be based on the best information available at the time the estimate is made. These proposals therefore recommend that the estimates for the 31 March 1998 and 31 March 1999 are based on the progress position of clinical negligence cases as at 31 December 1999. This will allow the 1998/99 I&E charge to be computed as a first stage in the Accounts preparation exercise. (This stage should be completed by 31 March 2000). It is envisaged that the provision estimate for 31 March 2000 will be completed by 15 May 2000 on the basis of case progress position pertaining at 31 March 2000. (The two staged approach is proposed in order that the workload particularly for legal advisers (at the CSA who will have the greatest volume of work) is managed and monitored over a reasonable period and there is adequate time to resolve any difficulties encountered. It also allows external auditors to identify any issues of concern during any interim audit).

(b)

(c)

Step 1 of Appendix 2 Guidance on the Calculation of Clinical Negligence Provision advises: Obtain information from legal advisers as to the expected outcomes of the claim their related probabilities and expected settlement date. It is proposed that estimates of forecast settlements (plus costs) are sought from legal advisers for the highest value cases with the objective of offering legal advisers 80% of the total value of the reserve amounts placed. This is aimed to reduce to a manageable level the number of cases to be referred to legal advisers. It is also proposed that a de minimus reserve value of 50,000 is set for cases to be referred to legal advisers (with the exception of the random sample described below). Estimates for cases with reserve amounts less than 50,000 will rely on the reserve amounts, which should be adjusted as necessary to include expected legal costs and reflect the outcome of the random sample described below.

(d)

Deriving Confidence in Reliability of Reserve Estimates on Cases Not Referred to Legal Advisers In addition to the above 80% coverage of the total reserve value or cases over 50,000 settlement value, it is proposed that a 3% random sample of the remaining cases is referred for legal estimate, in order to derive confidence in the reliability of reserve estimates on cases not referred to legal advisers under (c) above. Using the outcome of this random sample, remaining unreferred reserves should be adjusted as appropriate. Similarly the outcome of this random sample should be used to forecast the settlement dates for the remainder of cases not referred to legal advisers. For HSS bodies whose claims all have a reserve settlement value of less than 50,000, the aim should be to ensure 80% coverage of the total claims value.

(e)

Data Required from Legal Advisers Boards and Trusts should identify the cases to be referred to legal advisers as soon as possible to allow adequate time for the provision of the following data: (i) (ii) (iii) (iv) (vi) Maximum Forecast Settlement including Costs Minimum Forecast Settlement including Costs Probability of (i) Probability of (ii) (with (iii) and (iv) = 100%) Expected Settlement Date.

Some legal advisers may prefer to give a most likely financial outcome as well, together with a probability. This is quite acceptable provided

probabilities total 100%. It is recommended that the estimation process is based as far as possible on the advice provided by legal advisers, based on the most up-to-date information. (f) (g) The FRS requires discounting of provisions and subsequent unwinding of discount. Calculation of Provisions for 31 March 1998 and 31 March 1999 It is important to include in provisions at the above dates those cases which have subsequently been settled, on the basis of the actual costs incurred. Similarly new incidents arising in the interim should not be included. The following paragraphs outline a timetable for the provision of information which must be adhered to. 4. CSA Co-ordination of Post Trust Provisions (i) Stage I Each HSS body is required to submit to CSA by Wednesday 29 March 2000, a provision amount, calculated consistent with the extant guidance for each of the two financial year ends: (a) (b) (ii) 31 March 1998 31 March 1999

Stage II Each HSS body is required to submit to CSA by Wednesday 10 May a provision amount calculated consistent with extant guidance for the 1999/2000 year; and, (c) at 31 March 2000

HSS bodies should retain detailed working papers supporting provisions for external audit. Only total provision amounts should be submitted to CSA.

Appendix 2 CALCULATION OF CLINICAL NEGLIGENCE PROVISION The following steps must be followed when a clinical negligence claim first arises and at each review. It is obligatory to review each provision at each balance sheet date. 1. 2. 3. 4. Obtain information from legal advisers as to the expected outcomes of the claim, their related probabilities and the expected settlement date. Calculate the expected values over the length of time to the expected settlement date. Discount the two expected values over the length of time to the expected settlement date. Account for the total discounted value as a provision.

At the end of each financial year the following steps will be necessary: 5. Unwind the discount of the provision by one year. Account for the adjustment as interest payable. Then steps 1 4, above, adjusting the provision already accounted for, as necessary. This might be most easily done by writing back the provision and already made and replacing with new figures calculated from steps 1 4. A worked example is attached. The example follows the same numbering as the steps above.

Accounting For Provisions Calculation of a Provision Amount WORKED EXAMPLE 1. A claim is received during the first half of 1999 and legal advice is that the various expected outcomes and related probabilities are: 800,000 10,000 60% 40% (defence legal costs only)

the claim is expected to settle in 5 years time. 2. Expected values are calculated by multiplying each share by the related probability and finding the total for the various outcomes: Forecast Settlement 800,000 10,000 3. Expected Probability 60% 40% Expected Value 480,000 4,000 484,000

Discount by multiplying the expected values by factor for five years from discount tables (Annex F) to find the provision: Provision = 484,000 x 0.7473 = 361,693

4.

Accounting entries: Dr: Expenditure Cr: Provision 361,693 361,693

5.

Unwinding of discount at year-end. At the year-end the discount on the provision must be unwound by one year. This increases the provision as the settlement date gets closer. Unwind discount as the provision. 361,693 x 6% = 21,702 Entries Dr Interest Payable 21,702 Cr Provisions 21,702 Note: Discount on any debtor must also be accounted for.

Accounting 2000/01 At 31/3/01 the claim is reviewed, with new information obtained from the legal advisers. Before taking steps 1-6, reverse the entries above for the provision. This allows direct application of the new figures rather than calculating the adjustments to the old figures: Dr: Provision Cr: Expenditure 1. 361,693 + 21,702 = 383,395 361,693 + 21,702 = 383,395

Legal advice is now that the expected outcomes and related probabilities are: 1m 15,000 90% 10% (defence legal costs only)

and that the claim will settle in 3 years time. 2. Expected values: Forecast Settlement 1m 15,000 3. Expected value 900,000 1,500 901,500

Probability 90% 10%

Discount over 3 years: Provision = 901,500 x 0.8396 = 756,899

4.

Accounting entries: Dr: Expenditure Cr: Provision 756,899 756,899

5.

Highest forecast outcome in 1m. Discounted figures are: 1m x 0.836 = 839,600

ANNEX C FRS 12: RESTRUCTURINGS Summary 1. FRS 12 provides significant new regulations for the making of provisions for restructurings. It defines a restructuring as a programme that is planned and controlled by management and materially changes either the scope or manner of the business. Before a provision can be recognised there must be a constructive obligation to restructure. This arises only when there is a detailed formal plan for the restructuring and when a valid expectation has been raised in those affected that the restructuring will be carried out. A restructuring provision can include only expenditures which are necessary for the restructuring and which are not associated with ongoing activities. The specific requirements of FRS 12 in relation to restructurings are brought together below. From these, HSS bodies should be able to determine whether or not they should make a provision in the circumstances of a particular restructuring and, if so, which expenditures should be included in the provision. Definition of a Restructuring 2. FRS 12 defines a restructuring as a programme that is planned and controlled by management, and materially changes either: 3. the scope of a business undertaken by an entity; or the manner in which the business is conducted.

The standard includes the following as examples of events that may fall under the definition of restructuring: sale or termination of a line of business; changes in management structure, for example, eliminating a layer of management; and fundamental reorganisations that have a material effect on the nature and focus of the entitys operations.

Constructive Obligations 4. One of the requirements before a provision can be recognised is that there must have been an obligating event. For an event to be an obligating event, the entity must have no realistic alternative to settling the obligation arising from it. A constructive obligation arises when an event (which may be an action of the entity) creates valid expectations in other parties that the entity will discharge the obligation. A management or board decision alone is insufficient. FRS 12 states that a constructive obligation to restructure arises only when an entity: has a detailed formal plan for the restructuring, identifying at least: the business or part of a business concerned: the principal locations affected: the location, function, and approximate number of employees who will be compensated for terminating their services; the expenditures that will be undertaken; and when the plan will be implemented; and

5.

has raised a valid expectation in those affected that it will carry out the restructuring by starting to implement that plan or announcing its main features to those affected by it.

6.

Evidence that an entity has started to implement a restructuring plan would be provided by, for example, selling assets or by the public announcement of the main features of the plan, sufficient to give rise to valid expectations in other parties such as customers, suppliers and employees (or their representatives) that the entity will carry out the restructuring. For a plan to be sufficient to give rise to a constructive obligation when communicated to those effected by it, its implementation needs to be planned to begin as soon as possible and to be completed in a timeframe that makes significant changes to the plan unlikely. If it is expected that there will be a long delay before the restructuring begins or that the restructuring will take an unreasonably long time, it is unlikely that the plan will raise a valid expectation on the part of others that the entity is at present committed to restructuring, because the timeframe allows opportunities for the entity to change its plans. A management or board decision to restructure taken before the balance sheet date does not give rise to a constructive obligation at the balance sheet date unless the entity has, before the balance sheet date:

7.

8.

started to implement the restructuring plan; or announced the main features of the restructuring plan to those affected by it in a sufficiently specific manner to raise a valid expectation in them that the entity will carry out the restructuring.

9.

Although a constructive obligation is not created solely by a management decision, an obligation may result from other earlier events together with such a decision. For example, negotiations with employee representatives for termination payments, or with purchasers for the sale of an operation, may have been concluded subject only to board approval. Once that approval has been obtained and communicated to the other parties, the entity has a constructive obligation to restructure, if the conditions of paragraph 5, above, are met. No obligation arises for the sale of an operation until the entity is committed to the sale, ie there is a binding sale agreement.

10.

Contents of a Provision 11. FRS 12 requires that a restructuring provision should include only the direct expenditures arising from the restructuring, which are those that are both: 12. necessarily entailed by the restructuring: and not associated with the ongoing activities of the entity.

The standard also states that a restructuring provision does not include such costs as: retraining or relocating continuing staff; marketing; or investment in new systems and distribution networks.

These expenditures relate to the future conduct of the business and are not liabilities for restructuring at the balance sheet date. 13. Gains on the expected disposal of assets are not taken into account in measuring a restructuring provision, even if the sale of assets is envisaged as part of restructuring.

Post Balance Sheet Events 14. In some cases the entity starts to implement the restructuring plan, or announces its main features to those affected by it, only after the balance sheet date. Disclosure may be required under SSAP 17 Accounting for post balance sheet events if the restructuring is of such importance that its non-disclosure would affect the ability of the users of the financial statements to make proper evaluations and decisions.

ANNEX D FRS 12: EARLY RETIREMENTS 1. 2. The funding and accounting arrangements for the costs of early retirements in HSS bodies were addressed in HSS(F)10/96 and HSS(F)17/97. These circulars still apply. Under those circulars, provisions have to be made for early retirement costs post April 1995 where the quarterly billing option is available and chosen. The provision is the amount that would have been paid had the liability been settled by a single lump sum payment. This provision will now extend to all early retirement costs. In addition, in respect of those early retirement costs already provided for if the amounts provided for have been discounted, the unwinding of the discount application to the calculation will have to be recognised as interest payable. In 1999/2000, the unwinding of the discount in respect of that year, and earlier years if appropriate, should be charged as interest payable in the Income and Expenditure Account. In future years the discount should be unwound for that year only. This is achieved at the end of the year by multiplying the amount of the provision outstanding by 0.06 to obtain the interest payable charge.

3.

ANNEX E FRS 12: REPAIRS AND MAINTENANCE 1. Under FRS 12, a provision is a form of liability and the standard states that it is only liabilities which exist at the balance sheet date that should be recognised. Through a series of examples, FRS 12 makes it clear that no provisions should be made for repairs and maintenance to owned assets, even when: 2. as well as a base level each year, there is substantial expenditure every few years; there is a legal requirement to repair/maintain; under law there is a date by which certain repairs/maintenance should be carried out, the date has passed and the work has not been done.

The FRS states that, in each of these cases, there is no obligation independent of the entitys future actions to undertake the repairs and maintenance. It adds, however, that an obligation might arise to pay fines or penalties under legislation, since the obligating event for this has occurred when there is non-compliance with a statutory requirement. The assessment of probability of incurring fines or penalties depends on the detail of the legislation and the stringency of the enforcement regime. As a result, a provision may be appropriate for the best estimate of any fines and penalties ie if their payment is probable. If fines/penalties are possible but not probable, a contingent liability disclosure will be appropriate. The above does not apply where you lease premises under an operating lease and, as part of the leasing contract, you are obliged to maintain the premises. In such cases provisions can be recognised because there is a third party to whom the obligation is owed. Any past provisions for repairs and maintenance of owned assets must be written back in 1999/2000 as a prior period adjustment.

3.

4.

5.

ANNEX F OTHER CLAIMS Other claims, eg personal injury, and public and employers liability, which fulfil the recognition criteria of FRS 12 will have to be accounted for. The amount recognised should again be the best estimate of the expenditure required to settle the present obligation at the balance sheet date.

ANNEX G Discounting 1. FRS 12 states that: Where the effect of the time value of money is material, the amount of a provision should be the present value of the expenditures expected to be required to settle the obligation. This means that, where there is a significant period between the making of the provision and its forecast settlement, the amount of the provision must be discounted. Then as the settlement of the provision approaches, the amount of the provision must be increased nearer to the final expected settlement figure. This requires unwinding of the discount each year. The Accounting Standards Board requires this increase in the provision to be accounted for as interest payable. 2. Treasury directs that discounting should be at 6% per annum. This is a real discount rate to be applied to provisions at present day prices ie the discounting is to take account of time value of money and not inflation. For instance, if it is expected that a clinical negligence claim will be settled at 100k (at todays prices) in 3 years time, the provision should be discounted over 3 years. The amount to include in the accounts at the outset would be: 100k x 1 1.06 x 1 1.06 x 1 1.06

or 100k x 0.8396 = 83.96k After one year the discount should be unwound by one year ie the provision would increased to: 83.96k x 1.06 = 89K Dr: Interest payable Cr: Provision After another year this would increase to: 89k x 1.06 = 94.34k Dr: Interest payable Cr: Provision 5.34k 5.34k 5.04k 5.04k

and the final years unwinding of the discount would increase the provision to the expected settlement figure at the correct time for settlement: 94.34k x 1.06 = 100k Dr: Interest payable Cr: Provision 5.66k 5.66k

3. 4.

The discount factors over ten years are provided in the Appendix to this Annex. The subject of discounting is discussed fully in the Accounting Standard Boards Working Paper: Discounting in Financial Reporting April 1997 (available from ASB Publications tel 01908 230344 cost 5). Generally, it will be necessary to discount clinical negligence provisions. Provisions for early retirements and structured clinical negligence settlements are at present value and hence are always discounted. In other circumstances, judgement should be applied as to whether or not discounting would make a material difference. Wherever provisions are discounted, the discount must be unwound over the subsequent years.

5.

Appendix 1 of Annex G PRESENT VALUE OF 1 DISCOUNTED AT 6% PER YEAR The present values are calculated from the equation Where r is the number of years Year 1 2 3 4 5 6 7 8 9 10 Present Value (discount factor) 0.9434 0.8900 0.8396 0.7921 0.7473 0.7050 0.6651 0.6274 0.5919 0.5584 1 x 1 1.06r

ANNEX H PRIOR PERIOD ADJUSTMENTS FRS 3 states that prior period adjustments should be accounted for by restating the comparative figures for the preceding period in the primary statements and notes and adjusting the opening balance of reserves for the cumulative effect. The cumulative effect of the adjustments should also be noted at the foot of the statement of total recognised gains and losses of the current period. The effect of prior period adjustments on the results of the preceding period should be disclosed where practicable. Where prior period figures are restated, this should be indicated in the heading to the comparative figures on each page of the financial statements. Therefore in accordance with the above the price year figures 1998/99 have to be restated as if this accounting policy applied in 1998/99. This will result in a change to the reported results for that year. The opening provision as at 1 April 1998 (ie the amount which would have been provided for in the 1996/97 accounts had the policy applied) will also have to be established in order to calculate the adjustment to the opening reserves of the prior year for the notes to the accounts. The overall adjustment to the reserves will be the cumulative adjustment relating to the change in results for the previous year and the adjustment for the prior years.