A provision is a liability of uncertain timing or amount.
A provision should be recognized when and only when:
- an entity has present obligation (legal or constructive) as result of past events
- it is probable (i.e more likely than not) that an outflow of resources embodying economic benefits will be required to settle the obligations; and
- a reliable estimate can be made on the amount of obligation
Assessing whether there is a present obligation can be problematic
- There must be actual obligation. This means there must be no reasonable way of avoiding settlement. Just because a payment would be in the entity’s interest is not by itself an obligation on the entity to make the payment.
- This obligation must be as result of past event, called an obligating event. If obligation is dependent on future event, it is not present obligation.
- For constructive obligation to qualify as present obligation there must be a valid expectation that the entity will discharge the obligation and the entity must intend to discharge it.
- In a rare cases it is not clear whether there is a present obligation. in these cases, a past event is deemed to give rise to a present obligation if, taking account of all available evidence, it is more likely than not that a present obligation exist at the balance sheet date.
An outflow of economic benefit is deemed to be probable if it is more likely than not to occur. This generally means more than 50% likely. Just because the outflow is probable does not automatically mean there is an obligation. There must be an obligating event as well.
The IAS 37 note that, it is only in extremely rare cases that a reliable estimate will not be possible.
If anyone of the above three condition is not met, there is contingent liability and disclosure of this should be made if material.