TUTORIALS

PROVISION: As a Liability

Provision is a liability of indeterminate timing or quantity, categorically present at the end of reporting period. The core of this provision is that there is vagueness of timing and amount of the expenditure. It is correspondingly has improbability that differentiates provision from other liabilities. It is a current responsibility of an entity from past event that gives rise to an obligation. Past events may create two types of obligations, legal obligation that is derived from operation of law, meaning it is dictated by existing legal principles such as court decision and constructive obligation which is derived from entity’s actions such as entity’s practices or acceptance of responsibility. Provision is accepted when all of the following conditions are met:

  •  There is a present obligation, whether legal or constructive, as a result of a past obligating event. If the obligation can be avoided by future actions, then provision is not recognized.
  • There is a high probability of outflow of economic benefit required to settle the obligation. ( Numerically more than 50% ) If the probability is less than 50%, the company may just disclose it as contingent liability.
  •  There must be a reliable estimate. In rare case wherein no reliable estimate can be made, liability exists but it cannot be recognized.

About the accounting handling, there is no variance between provisions created by legal or constructive obligation but it may help in ascertaining the timing of recognition of the provision.