AccountingWEB.co.uk guide to provisions and contingencies

Steve Collings offers a summary of the reporting provisions relating to provisions, contingent liabilities and contingent assets.

Provisions, contingent liabilities and contingent assets can often cause confusion among accountants, particularly in deciphering when to recognise a provision or disclosing a contingency. This article looks at the requirements set out in FRS 12 and IAS 37 ‘Provisions, Contingent Liabilities and Contingent Assets’ and FRS 21 / IAS 10 ‘Events After the Reporting Date’ and discusses when and when not to recognise a provision.

Definitions
A provision is a liability that is of uncertain timing or amount, to be settled by the transfer of economic benefits.

A contingent liability is:

(a) A possible obligation arising from past events whose existence will be confirmed only by the occurrence of one or more uncertain future events not wholly within the entity’s control, or;

(b) A present obligation that arises from past events but is not recognised because it is not probable that a transfer of economic benefits will be required to settle the obligation or because the amount of the obligation cannot be measured with sufficient reliability.

A contingent asset is a possible asset arising from past events whose existence will be confirmed only by the occurrence of one or more uncertain future events not wholly within the entity’s control.

Recognition of a provision
FRS 12 and IAS 37 are identical in nature and contain three criteria which must be met before a provision can be recognised in the financial statements. These criteria are:
(a)  The 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.
(c)  A reliable estimate can be made of the amount of the obligation.

Now let's look at some practical examples...

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