IAS 37 requires a provision to be recognised when three conditions are met together: the entity has a present obligation (legal or constructive) 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; and a reliable estimate can be made of the amount of the obligation. If these conditions are not met, no provision is recognised.
Definition of a Provision and Its Recognition Criteria
The Standard defines a provision as a liability of uncertain timing or amount. It states expressly that a provision shall be recognised when: (a) an entity has a present obligation (legal or constructive) as a result of a past event; (b) it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and (c) a reliable estimate can be made of the amount of the obligation. If these conditions are not met, no provision shall be recognised.
The Difference Between Provisions and Contingent Liabilities
The Standard clearly distinguishes provisions from contingent liabilities. Provisions are recognised as liabilities, assuming that a reliable estimate can be made, because they are present obligations and it is probable that an outflow of resources embodying economic benefits will be required to settle the obligations. Contingent liabilities, on the other hand, are not recognised as liabilities because they are either possible obligations, as it has yet to be confirmed whether the entity has a present obligation that could lead to an outflow of resources embodying economic benefits, or present obligations that do not meet the recognition criteria in the Standard.
The Standard defines a contingent liability as a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity; or a present obligation that arises from past events but is not recognised because 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 cannot be measured with sufficient reliability.
What Is the "Obligating Event" That Creates the Present Obligation?
The Standard calls the past event that creates a present obligation an obligating event, and explains that for an event to be an obligating event, it is necessary that the entity has no realistic alternative to settling the obligation created by the event. This is the case only where settlement can be enforced by law, or, in the case of a constructive obligation, where the event (which may be an action of the entity) creates valid expectations in other parties that the entity will discharge the obligation.
What Does "Probable" Mean in This Context?
The Standard clarifies that an outflow of resources or other event is regarded as probable if the event is more likely than not to occur, ie the probability that the event will occur is greater than the probability that it will not.
No Provisions for Future Operating Costs
The Standard clarifies that no provision is recognised for costs that need to be incurred to operate in the future, because financial statements deal with the financial position of an entity at the end of its reporting period, not its possible position in the future.
Legal References
- IAS 37 — Provisions, Contingent Liabilities and Contingent Assets, paragraph 10 (definitions of provision and contingent liability)
- IAS 37 — Provisions, Contingent Liabilities and Contingent Assets, paragraph 14 (recognition criteria for a provision)
- IAS 37 — Provisions, Contingent Liabilities and Contingent Assets, paragraph 13 (distinguishing provisions from contingent liabilities)
- IAS 37 — Provisions, Contingent Liabilities and Contingent Assets, paragraph 17 (definition of an obligating event)
- IAS 37 — Provisions, Contingent Liabilities and Contingent Assets, paragraph 23 (definition of "probable")
- IAS 37 — Provisions, Contingent Liabilities and Contingent Assets, paragraph 18 (no provisions for future operating costs)
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