Provision, accrual or contingent liability: test the obligation first
A year-end schedule headed 'provisions' lists four items: £5,000 of maintenance done but not yet invoiced, £40,000 for a claim over past harm, a separate £12,000 exposure and £8,000 budgeted for next year's advertising. Under UK-adopted IAS 37, only the claim can be a provision, and even that depends on the evidence. Start with one question: does a present obligation exist because of a past event? Probability of an outflow and a reliable estimate come next, and together they decide whether to recognise a liability, disclose a contingent liability or record nothing.
Three tests, in order
IAS 37 paragraph 14 recognises a provision only when three conditions are met: a present legal or constructive obligation as a result of a past event, a probable outflow of resources to settle it, and a reliable estimate of the amount. A provision is a liability of uncertain timing or amount. An accrual is different. It covers goods or services already received, and its uncertainty is generally much smaller (paragraph 11). The £5,000 of maintenance has been performed and an invoice is expected, so it is an accrual.
The label matters because it changes what appears in the accounts now, what the notes must say and what the balance can later be used for. This is the UK-adopted IFRS position, not FRS 102 or US GAAP. Some obligations fall under other standards, such as financial instruments under IFRS 9 and customer refunds under IFRS 15.
Sources and context, checked :
Sorting the four items
The judgements in this table are stipulated for a hypothetical example. Amounts are in pounds, each item is assumed material, there are no reimbursements or tax effects, and settlement is close enough that discounting is immaterial. A claim letter or a threat alone would not establish any of these conclusions, and whether an obligation exists is often a legal question.
A contingent liability is not recognised. It is disclosed unless the possibility of an outflow is remote (paragraphs 27 to 28 and 86). The advertising budget fails the first test, because no past event obliges the business to spend it. Costs of running the business in future, and future operating losses, are not provisions (paragraphs 18 and 63).
| Item at year end | Evidence assumed | Treatment |
|---|---|---|
| Maintenance not yet invoiced, £5,000 | Work received, invoice expected | Accrual of £5,000 |
| Claim for past harm | Advice supports a present obligation, a probable outflow and a best estimate of £40,000 | Provision of £40,000 |
| Separate exposure, £12,000 | Possible obligation, or outflow not probable, but not remote | No liability; disclose as a contingent liability |
| Advertising budget, £8,000 | No past obligating event | Nothing recognised |
Sources and context, checked :
Measuring and using the claim provision
Paragraph 36 measures a provision at the best estimate of the expenditure required to settle the obligation at the reporting date. For a single obligation such as one claim, paragraph 40 asks for other possible outcomes to be considered, so mechanically multiplying the amount claimed by the probability of losing is not enough to establish the best estimate. Here, £40,000 is already the assessed best estimate. Where the time value of money is material, the provision is discounted (paragraph 45).
At the year end: Dr claim expense £40,000; Cr provision £40,000.
If the claim later settles for £40,000: Dr provision £40,000; Cr cash £40,000.
The settlement uses the provision. It does not create a second expense. Paragraphs 59 and 61 require a review at each reporting date and allow a provision to be used only for the expenditure it was originally recognised for, so an unused balance cannot quietly absorb unrelated costs.
The IASB was still redeliberating proposed targeted improvements to IAS 37 at its 23 September 2026 meeting. Those tentative decisions are proposals and do not change the current recognition tests.
Before signing off the schedule
For each line, record the past event and its date, the evidence of a legal or constructive obligation, the probability assessment and who made it, the amount or range and how the best estimate was chosen, the expected timing, the disclosure decision and the reviewer. Retitle anything that fails the first test before anyone debates its amount.