A provision is a recognized liability with uncertain timing or amount, measured from the best estimate of the resources needed to settle the obligation.
A provision is a recognized liability whose timing or amount is uncertain. Under IAS 37, it arises from a present legal or constructive obligation created by a past event, when an outflow of economic resources is probable and the obligation can be estimated reliably.
A provision is not a pot of cash and is not simply profit set aside for a possible future cost. It is an accounting liability supported by an existing obligation. Terminology and recognition thresholds differ under other frameworks, including U.S. GAAP, so the applicable standard must be checked.
IAS 37 requires all three conditions for recognition:
If a present obligation exists but an outflow is not probable, the item is generally treated as a contingent liability rather than recognized as a provision. If the chance of outflow is not remote, note disclosure is generally required under IAS 37.
These are IFRS terms. U.S. GAAP commonly addresses uncertain losses through the loss-contingency model in ASC 450 and can reach a different recognition or measurement result.
A legal obligation can arise from a contract, legislation, or other operation of law. A constructive obligation can arise when an entity’s established practice, published policy, or sufficiently specific statement creates a valid expectation in other parties that it will accept particular responsibilities.
A board decision alone does not necessarily create a constructive obligation. For example, a restructuring plan may require communication of its main features to affected parties before the entity has created the relevant expectation.
| Provision type | Past event | Main uncertainty |
|---|---|---|
| Product warranty | Sale of products with warranty coverage | Claim frequency and repair cost |
| Environmental restoration | Operation or damage creating a legal or constructive duty | Scope, timing, remediation cost |
| Litigation | Event giving rise to a present legal obligation | Outcome, damages, legal cost, timing |
| Onerous contract | Existing contract whose unavoidable costs exceed expected benefits | Exit cost and cost of fulfillment |
| Restructuring | Qualifying constructive obligation from a detailed plan | Eligible direct expenditures and timing |
| Customer refunds | Sales under an established refund policy | Return rate and amount refunded |
Future operating losses do not qualify merely because management expects them. They do not arise from a present obligation at the reporting date.
A manufacturer sells 10,000 products with a one-year warranty. Based on product data and current expectations:
For a large population of similar obligations, an expected-value technique can be appropriate. The estimated cost per product is:
The initial provision is:
The entry is:
1Dr Warranty expense $68,000
2 Cr Warranty provision $68,000
If the company later settles $20,000 of valid claims, it uses the provision rather than recording the same expected warranty cost again:
1Dr Warranty provision $20,000
2 Cr Cash / inventory / payroll $20,000
At the next reporting date, the remaining provision is re-estimated using actual claims, remaining coverage, cost changes, and other current evidence.
IAS 37 describes measurement as the best estimate of the expenditure required to settle the present obligation or transfer it at the reporting date. The method depends on the obligation:
An expected reimbursement, such as insurance recovery, is evaluated separately under the applicable requirements. It should not be assumed merely because management expects another party to pay.
| Term | Recognized as liability? | Main distinction |
|---|---|---|
| Provision | Yes, when recognition criteria are met | Timing or amount is uncertain |
| Accrued expense | Usually yes | Often less uncertain and tied to goods or services already received |
| Contingent liability | Generally no under IAS 37 | Possible obligation, or present obligation failing recognition criteria |
| Reserve | Not necessarily | Often an equity appropriation or another framework-specific label, not the IAS 37 liability |
| Allowance for doubtful accounts | No | Contra-asset valuation allowance reducing receivables |
Older or informal usage may call depreciation or credit-loss allowances “provisions.” That wording should not be confused with the IAS 37 definition.
Provision accounting can depend on legal and technical evidence. This page is educational and does not provide accounting, audit, tax, legal, credit, or investment advice.