Consideration of risk in accounting

The concept of risk is central to the management company. We can define risk as a potential event that may prevent the company from achieving its objectives. The risk is still characterized by two elements: the probability of occurrence and severity measured by an estimate of the damage caused by the realization of the risk. Accounting which aims to translate the economic activity of a company takes into account partially the risks to which the company is exposed.

risk in accounting

Consideration of risk in provisions for risks and charges
The standard IAS 37 defines the provision as a liability including the amount or the maturity is uncertain and imposes three conditions:

  • There must be a present obligation as a result of a past event;
  • It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation;
  • It is possible to estimate the amount of the obligation reliably.

The General Accounting Plan is aligned with the definition (PCG art 312-1).

The first two conditions are related to the occurrence but a restrictive approach since the obligation to be present. This means that the potential risks are excluded from the provisions. For example, an ongoing dispute with a third party generates a present obligation against by potential trial should not be provisioned.

The third condition relates to gravity. Gravity axis (or amount) is only evaluated in terms of reliability; the importance of the amount is ignored. The reading of the standard under means so that the accountant does not attach to the importance of the risks but the possibility of a reliable encryption.

Broadening the consideration of risk with contingent liabilities
IAS 37 defines a contingent liability as:

  • A possible obligation of the entity resulting from past events and whose existence will be confirmed only by the occurrence of one or more uncertain future events not wholly within the control of the entity;
  • Or a present obligation arising from past events but is not recognized because either it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation or the amount of the obligation can not be measured reliably.

Contingent liabilities can extend the consideration of risks to the less probable elements or difficult to quantify. However, contingent liabilities not give rise to any accounting records, only an information in the annex is required if the importance is significant.

Consideration of risk is imperfect in accounting
The accounting is by essence turned toward the past and integrates more difficult the uncertainty of the future and therefore the risks. The accounting risk approach based on a hierarchy between the probability of occurrence and severity. The accrued accounting risks including the probability is high and then considers the seriousness. In other words, a probability of 1% to 100 million loss, or 1 million will not be provisioned, against by a 99% to 1 million losses will accrue.

In conclusion, the economic reality of companies in risk is reflected partially in accounting, important risks are ignored as unlikely. The question therefore arises of a accounting information more complete including in annex on the risks to which the organization is exposed.