The following terms are used in this Standard with the meanings
A provision is a liability of uncertain timing or amount.
A liability is a present obligation of the entity arising from past events,
the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.
An obligating event is an event that creates a legal or constructive
obligation that results in an entity having no realistic alternative to settling that obligation.
A legal obligation is an obligation that derives from:
a contract (through its explicit or implicit terms);
other operation of law.
A constructive obligation is an obligation that derives from an entity's
by an established pattern of past practice, published policies or a
sufficiently specific current statement, the entity has indicated to
other parties that it will accept certain responsibilities; and
as a result, the entity has created a valid expectation on the part of
those other parties that it will discharge those responsibilities.
A contingent liability is:
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
it is not probable that an outflow of resources embodying
economic benefits will be required to settle the obligation;
the amount of the obligation cannot be measured with
A contingent asset is a possible asset 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.
An onerous contract is a contract in which the unavoidable costs of
meeting the obligations under the contract exceed the economic benefits expected to be received under it.
A restructuring is a programme that is planned and controlled by
management, and materially changes either:
the scope of a business undertaken by an entity; or
the manner in which that business is conducted.
Provisions and other liabilities
Provisions can be distinguished from other liabilities such as trade payables and
accruals because there is uncertainty about the timing or amount of the future
expenditure required in settlement. By contrast:
trade payables are liabilities to pay for goods or services that have been received or supplied and have been invoiced or formally agreed with the
accruals are liabilities to pay for goods or services that have been
received or supplied but have not been paid, invoiced or formally agreed with the supplier, including amounts due to employees (for example, amounts relating to accrued vacation pay). Although it is sometimes necessary to estimate the amount or timing of accruals, the uncertainty is generally much less than for provisions.
Accruals are often reported as part of trade and other payables, whereas
provisions are reported separately.
Relationship between provisions and contingent
In a general sense, all provisions are contingent because they are uncertain in
timing or amount. However, within this Standard the term 'contingent' is used for liabilities and assets that are not recognised because their 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. In addition, the term 'contingent liability' is used for liabilities that do not meet the recognition criteria.
This Standard distinguishes between:
provisions - which 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; and
contingent liabilities - which 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 this Standard (because either it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation, or a sufficiently reliable estimate of the amount of the obligation cannot be made).
A provision shall be recognised when:
an 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 shall be recognised.
In 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 exists at the end of the reporting period.
In almost all cases it will be clear whether a past event has given rise to a present obligation. In rare cases, for example in a lawsuit, it may be disputed either whether certain events have occurred or whether those events result in a present obligation. In such a case, an entity determines whether a present obligation exists at the end of the reporting period by taking account of all available evidence, including, for example, the opinion of experts. The evidence considered includes any additional evidence provided by events after the
reporting period. On the basis of such evidence:
where it is more likely than not that a present obligation exists at the end of the reporting period, the entity recognises a provision (if the
recognition criteria are met); and
where it is more likely that no present obligation exists at the end of the
reporting period, the entity discloses a contingent liability, unless the possibility of an outflow of resources embodying economic benefits is remote (see paragraph 86).
A past event that leads to a present obligation is called an obligating event. 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 the settlement of the obligation 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.
Financial statements deal with the financial position of an entity at the end of its reporting period and not its possible position in the future. Therefore, no provision is recognised for costs that need to be incurred to operate in the future. The only liabilities recognised in an entity's statement of financial position are those that exist at the end of the reporting period.
It is only those obligations arising from past events existing independently of an entity's future actions (ie the future conduct of its business) that are recognised as provisions. Examples of such obligations are penalties or clean-up costs for unlawful environmental damage, both of which would lead to an outflow of resources embodying economic benefits in settlement regardless of the future actions of the entity. Similarly, an entity recognises a provision for the decommissioning costs of an oil installation or a nuclear power station to the extent that the entity is obliged to rectify damage already caused. In contrast, because of commercial pressures or legal requirements, an entity may intend or need to carry out expenditure to operate in a particular way in the future (for example, by fitting smoke filters in a certain type of factory). Because the entity can avoid the future expenditure by its future actions, for example by changing its method of operation, it has no present obligation for that future expenditure and no provision is recognised.
An obligation always involves another party to whom the obligation is owed. It is not necessary, however, to know the identity of the party to whom the obligation is owed—indeed the obligation may be to the public at large. Because an obligation always involves a commitment to another party, it follows that a management or board decision does not give rise to a constructive obligation at the end of the reporting period unless the decision has been communicated before the end of the reporting period to those affected by it in a sufficiently specific manner to raise a valid expectation in them that the entity will discharge its responsibilities.
An event that does not give rise to an obligation immediately may do so at a later date, because of changes in the law or because an act (for example, a
sufficiently specific public statement) by the entity gives rise to a constructive obligation. For example, when environmental damage is caused there may be no obligation to remedy the consequences. However, the causing of the damage will become an obligating event when a new law requires the existing damage to be rectified or when the entity publicly accepts responsibility for rectification in a way that creates a constructive obligation.
Where details of a proposed new law have yet to be finalised, an obligation arises only when the legislation is virtually certain to be enacted as drafted. For the purpose of this Standard, such an obligation is treated as a legal obligation. Differences in circumstances surrounding enactment make it impossible to specify a single event that would make the enactment of a law virtually certain. In many cases it will be impossible to be virtually certain of the enactment of a law until it is enacted.
Probable outflow of resources embodying economic benefits
For a liability to qualify for recognition there must be not only a present obligation but also the probability of an outflow of resources embodying economic benefits to settle that obligation. For the purpose of this Standard,1 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. Where it is not probable that a present obligation exists, an entity discloses a contingent liability, unless the possibility of an outflow of resources embodying economic benefits is remote (see paragraph 86).
Where there are a number of similar obligations (eg product warranties or similar contracts) the probability that an outflow will be required in settlement is determined by considering the class of obligations as a whole. Although the likelihood of outflow for any one item may be small, it may well be probable that some outflow of resources will be needed to settle the class of obligations as a whole. If that is the case, a provision is recognised (if the other recognition criteria are met).
Reliable estimate of the obligation
The use of estimates is an essential part of the preparation of financial statements and does not undermine their reliability. This is especially true in the case of provisions, which by their nature are more uncertain than most other items in the statement of financial position. Except in extremely rare cases, an entity will be able to determine a range of possible outcomes and can therefore make an estimate of the obligation that is sufficiently reliable to use in recognising a provision.
In the extremely rare case where no reliable estimate can be made, a liability exists that cannot be recognised. That liability is disclosed as a contingent liability (see paragraph 86).
The interpretation of 'probable' in this Standard as 'more likely than not' does not necessarily apply
in other Standards.
An entity shall not recognise a contingent liability.
A contingent liability is disclosed, as required by paragraph 86, unless the
possibility of an outflow of resources embodying economic benefits is remote.
Where an entity is jointly and severally liable for an obligation, the part of the obligation that is expected to be met by other parties is treated as a contingent liability. The entity recognises a provision for the part of the obligation for which an outflow of resources embodying economic benefits is probable, except in the extremely rare circumstances where no reliable estimate can be made.
Contingent liabilities may develop in a way not initially expected. Therefore, they are assessed continually to determine whether an outflow of resources embodying economic benefits has become probable. If it becomes probable that an outflow of future economic benefits will be required for an item previously dealt with as a contingent liability, a provision is recognised in the financial statements of the period in which the change in probability occurs (except in the extremely rare circumstances where no reliable estimate can be made).
An entity shall not recognise a contingent asset.
Contingent assets usually arise from unplanned or other unexpected events that give rise to the possibility of an inflow of economic benefits to the entity. An example is a claim that an entity is pursuing through legal processes, where the outcome is uncertain.
Contingent assets are not recognised in financial statements since this may result in the recognition of income that may never be realised. However, when the realisation of income is virtually certain, then the related asset is not a contingent asset and its recognition is appropriate.
A contingent asset is disclosed, as required by paragraph 89, where an inflow of economic benefits is probable.
Contingent assets are assessed continually to ensure that developments are appropriately reflected in the financial statements. If it has become virtually certain that an inflow of economic benefits will arise, the asset and the related income are recognised in the financial statements of the period in which the change occurs. If an inflow of economic benefits has become probable, an entity discloses the contingent asset (see paragraph 89).
The amount recognised as a provision shall be the best estimate of the
expenditure required to settle the present obligation at the end of the reporting period.
The best estimate of the expenditure required to settle the present obligation is the amount that an entity would rationally pay to settle the obligation at the
end of the reporting period or to transfer it to a third party at that time. It will often be impossible or prohibitively expensive to settle or transfer an obligation at the end of the reporting period. However, the estimate of the amount that an entity would rationally pay to settle or transfer the obligation gives the best estimate of the expenditure required to settle the present obligation at the end of the reporting period.
The estimates of outcome and financial effect are determined by the judgement of the management of the entity, supplemented by experience of similar transactions and, in some cases, reports from independent experts. The evidence considered includes any additional evidence provided by events after the reporting period.
Uncertainties surrounding the amount to be recognised as a provision are dealt with by various means according to the circumstances. Where the provision being measured involves a large population of items, the obligation is estimated by weighting all possible outcomes by their associated probabilities. The name for this statistical method of estimation is 'expected value'. The provision will therefore be different depending on whether the probability of a loss of a given amount is, for example, 60 per cent or 90 per cent. Where there is a continuous range of possible outcomes, and each point in that range is as likely as any other, the mid-point of the range is used.
An entity sells goods with a warranty under which customers are covered for
the cost of repairs of any manufacturing defects that become apparent
within the first six months after purchase. If minor defects were detected in
all products sold, repair costs of 1 million would result. If major defects were detected in all products sold, repair costs of 4 million would result. The entity's past experience and future expectations indicate that, for the
coming year, 75 per cent of the goods sold will have no defects, 20 per cent
of the goods sold will have minor defects and 5 per cent of the goods sold
will have major defects. In accordance with paragraph 24, an entity assesses the probability of an outflow for the warranty obligations as a whole.
The expected value of the cost of repairs is:
(75% of nil) + (20% of 1m) + (5% of 4m) = 400,000
Where a single obligation is being measured, the individual most likely outcome may be the best estimate of the liability. However, even in such a case, the entity considers other possible outcomes. Where other possible outcomes are either mostly higher or mostly lower than the most likely outcome, the best estimate will be a higher or lower amount. For example, if an entity has to rectify a serious fault in a major plant that it has constructed for a customer, the individual most likely outcome may be for the repair to succeed at the first attempt at a cost of 1,000, but a provision for a larger amount is made if there is a significant chance that further attempts will be necessary.
The provision is measured before tax, as the tax consequences of the provision, and changes in it, are dealt with under IAS 12.
Risks and uncertainties
The risks and uncertainties that inevitably surround many events and
circumstances shall be taken into account in reaching the best estimate of a provision.
Risk describes variability of outcome. A risk adjustment may increase the amount at which a liability is measured. Caution is needed in making judgements under conditions of uncertainty, so that income or assets are not overstated and expenses or liabilities are not understated. However, uncertainty does not justify the creation of excessive provisions or a deliberate overstatement of liabilities. For example, if the projected costs of a particularly adverse outcome are estimated on a prudent basis, that outcome is not then deliberately treated as more probable than is realistically the case. Care is needed to avoid duplicating adjustments for risk and uncertainty with consequent overstatement of a provision.
Disclosure of the uncertainties surrounding the amount of the expenditure is made under paragraph 85(b).
Where the effect of the time value of money is material, the amount of a
provision shall be the present value of the expenditures expected to be required to settle the obligation.
Because of the time value of money, provisions relating to cash outflows that arise soon after the reporting period are more onerous than those where cash outflows of the same amount arise later. Provisions are therefore discounted, where the effect is material.
The discount rate (or rates) shall be a pre-tax rate (or rates) that reflect(s) current market assessments of the time value of money and the risks specific to the liability. The discount rate(s) shall not reflect risks for which future cash flow estimates have been adjusted.
Future events that may affect the amount required to settle an obligation
shall be reflected in the amount of a provision where there is sufficient objective evidence that they will occur.
Expected future events may be particularly important in measuring provisions. For example, an entity may believe that the cost of cleaning up a site at the end of its life will be reduced by future changes in technology. The amount recognised reflects a reasonable expectation of technically qualified, objective observers, taking account of all available evidence as to the technology that will be available at the time of the clean-up. Thus it is appropriate to include, for example, expected cost reductions associated with increased experience in applying existing technology or the expected cost of applying existing technology to a larger or more complex clean-up operation than has previously been carried out. However, an entity does not anticipate the development of a completely new technology for cleaning up unless it is supported by sufficient objective evidence.
The effect of possible new legislation is taken into consideration in measuring an existing obligation when sufficient objective evidence exists that the legislation is virtually certain to be enacted. The variety of circumstances that arise in practice makes it impossible to specify a single event that will provide sufficient, objective evidence in every case. Evidence is required both of what legislation will demand and of whether it is virtually certain to be enacted and implemented in due course. In many cases sufficient objective evidence will not exist until the new legislation is enacted.
Expected disposal of assets
Gains from the expected disposal of assets shall not be taken into account
in measuring a provision.
Gains on the expected disposal of assets are not taken into account in measuring a provision, even if the expected disposal is closely linked to the event giving rise to the provision. Instead, an entity recognises gains on expected disposals of
assets at the time specified by the Standard dealing with the assets concerned.
Where some or all of the expenditure required to settle a provision is expected to be reimbursed by another party, the reimbursement shall be recognised when, and only when, it is virtually certain that reimbursement will be received if the entity settles the obligation. The reimbursement shall be treated as a separate asset. The amount recognised for the reimbursement shall not exceed the amount of the provision.
In the statement of comprehensive income, the expense relating to a provision may be presented net of the amount recognised for a reimbursement.
Sometimes, an entity is able to look to another party to pay part or all of the expenditure required to settle a provision (for example, through insurance contracts, indemnity clauses or suppliers' warranties). The other party may either reimburse amounts paid by the entity or pay the amounts directly.
In most cases the entity will remain liable for the whole of the amount in question so that the entity would have to settle the full amount if the third party failed to pay for any reason. In this situation, a provision is recognised for the full amount of the liability, and a separate asset for the expected reimbursement is recognised when it is virtually certain that reimbursement will be received if the entity settles the liability.
In some cases, the entity will not be liable for the costs in question if the third party fails to pay. In such a case the entity has no liability for those costs and they are not included in the provision.
As noted in paragraph 29, an obligation for which an entity is jointly and severally liable is a contingent liability to the extent that it is expected that the obligation will be settled by the other parties.
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