IAS 37 Provisions and Contingencies: A Practical Guide

What Is IAS 37?

IAS 37 Provisions, Contingent Liabilities and Contingent Assets establishes the criteria for recognising provisions, and the disclosure requirements for contingent liabilities and contingent assets. It is one of the most judgement-intensive standards in practice — the distinction between a provision (recognised on the balance sheet) and a contingent liability (disclosed in the notes) can be highly subjective and is frequently debated between preparers and auditors.

When to Recognise a Provision

A provision is recognised when three conditions are met: (1) a present obligation (legal or constructive) exists as a result of a past event, (2) it is probable that an outflow of economic benefits will be required to settle the obligation, and (3) a reliable estimate can be made of the amount. "Probable" means more likely than not (i.e. greater than 50%). The past event must have created a present obligation — a future action alone (e.g. deciding to restructure) is not sufficient without a public announcement or communication that creates a constructive obligation.

Measurement of Provisions

The best estimate of the expenditure required to settle the obligation at the balance sheet date. For large populations of items (e.g. warranty claims), expected value (probability-weighted average) is appropriate. For single large obligations, the most likely outcome may be most appropriate. Where the effect of the time value of money is material, the provision is discounted at a pre-tax risk-free rate.

Specific Application: Restructuring Provisions

A restructuring provision can only be recognised when a detailed formal plan exists AND the entity has raised a valid expectation in those affected that it will carry out the restructuring (by announcing the plan publicly or starting implementation). Future operating losses cannot be provided for. Only the direct costs of restructuring (redundancy, lease exit costs, asset write-offs) are included — not costs of ongoing activities.

Specific Application: Onerous Contracts

A contract is onerous when the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received. The provision is the lower of the cost of fulfilling the contract and the cost of exiting it (penalties for termination).

Contingent Liabilities

A contingent liability is a possible obligation whose existence depends on uncertain future events, or a present obligation where outflow is not probable or amount cannot be reliably estimated. Contingent liabilities are disclosed (not recognised) unless the possibility of outflow is remote. Common examples: litigation where outcome is uncertain, guarantees given to third parties.

Further Reading

• Accounting Standards CPD
• IAS 36 Impairment Guide
• ACCA FR Guide

CPD on IAS 37

Learnsignal's CPD includes IAS 37 provisions and contingencies modules with case studies. Explore CPD.

FAQ

Can you provide for future operating losses?

No — IAS 37 explicitly prohibits provisions for future operating losses. They do not meet the definition of a liability because there is no present obligation. The exception is onerous contracts, where unavoidable costs are provided for.