Importance of Provisions

Provision is considered as an expense of a business that is charged from the profits by debiting it to the Profit and Loss Account. The underlying principle behind the creation of provision is the accounting principle of Conservatism which states that provides for all anticipated expenses or losses but does not provide for anticipated incomes or gains’. It should be noted that the creation of provision is compulsory even if the business does not have profits. The main rationale for making provisions is to provide a cushion to the future business performance against the uncertain and unforeseen losses that may arise from the past transactions. The creation of a provision helps in determining the true profits or losses during an accounting period. Following are the importance of provisions.


Importance of Provisions


The following are the various purposes served by creating provisions.

Provide for Future Expenses or Losses: Provision is the amount kept aside out of profits to meet the future expected liabilities and losses. Therefore, it helps the business in meeting the expenses or losses that are expected to take place in the near future.

True Profits or Losses: The true profit or loss of a firm can be determined only when all the expenses or losses (whether they are paid/incurred or not are provided) i.e. debited to Profit and Loss Account. Provision is a charge against revenues or profits of a firm and therefore it helps in ascertaining the true profit or loss during an accounting period.

True and Fair Financial Position: By creating the provisions for anticipated expenses and losses the true financial position of an organization can be assessed at the end of an accounting period.


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