Question

Grant Company has had a record-breaking year in terms of growth in sales and profitability. However, market research indicates that it will experience operating losses in two of its major businesses next year. The controller has proposed that the company record a provision for these future losses this year, since it can afford to take the charge and still show good results. Advise the controller on the appropriateness of this charge

Short answer

The advice of the Controller to record a provision for future losses is not appropriate because GAAP allows recording provisions for those liabilities arising from past events.

Step-by-step solution

Meaning of Liability

Liability refersto the definite amount indebted by thebusiness entity towards another entity or individual. It can be short-term and long-term, depending on tenure.

Appropriateness of Controller advice

US GAAP allows the recording of provisions for liability that accrues due to past action but does not allow provisioning of future losses that do not relate to past actions. Here Controller is advising to record future losses this year to show good results that have no connection with the company's past activities. Therefore, it is not fulfilling the criteria of liability. Hence, the Controller's advice regarding the provision of future losses is not appropriate.