IAS 37
Active
Provisions, Contingent Liabilities and Contingent Assets
Prescribes the recognition, measurement and disclosure of provisions, contingent liabilities and contingent assets.
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Conceptual Framework Linkage
Why a provision is a genuine liability, and a contingency is not
The Conceptual Framework defines a liability as a PRESENT obligation to transfer an economic resource as a result of PAST events. IAS 37 operationalises exactly this boundary – a provision is a liability of UNCERTAIN timing or amount that meets the Framework's definition; a contingent liability is something that has NOT yet crossed that threshold, and so is disclosed rather than recognised.
HOW IAS 37 MAPS TO THE FRAMEWORK
Present obligation – must exist NOW, as a result of a PAST event, not merely a probable future cost Probable outflow – economic benefits must probably need to be given up to settle the obligation Reliable estimate – the amount of the obligation must be capable of reliable estimation, even if it involves a range or expected value
IAS 37 was historically introduced specifically to STOP entities recognising "big bath" provisions for future operating losses or vague future costs that did not yet represent genuine present obligations – it is, in many respects, an anti-abuse standard as much as a recognition standard.
Measurement principles applied
A provision is measured at the BEST ESTIMATE of the expenditure required to settle the obligation – a genuinely probability-weighted concept, not simply the most likely single outcome.
ScenarioBest estimate approach
Large population of items (e.g. warranty claims)EXPECTED VALUE – weighting all possible outcomes by their probability
Single obligationThe MOST LIKELY outcome may be the best estimate, though other possible outcomes are also considered
Qualitative characteristics in action: using a probability-weighted expected value rather than a single "best guess" figure reflects faithful representation – it captures the genuine range of uncertainty rather than an arbitrary point estimate.
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Scope & Applicability
What IAS 37 covers
IAS 37 applies to all provisions, contingent liabilities, and contingent assets, EXCEPT those resulting from executory contracts (unless the contract is ONEROUS), and those covered by another Standard.
SCOPE EXCLUSIONS – GOVERNED BY OTHER STANDARDS
Financial instruments (including guarantees) within IFRS 9's scope Executory contracts, UNLESS onerous Provisions specifically dealt with by another Standard – e.g. construction contracts (IFRS 15), income taxes (IAS 12), leases (IFRS 16), employee benefits (IAS 19), insurance contracts (IFRS 17)
"Executory contracts" are contracts under which NEITHER party has performed any of its obligations, or both parties have partially performed to an equal extent – these are generally outside IAS 37 UNLESS they become onerous (Section 6).
Key definitions you must know
Provision
A liability of UNCERTAIN timing or amount.
Contingent liability
EITHER (a) a possible obligation arising from past events, whose existence will be confirmed only by the occurrence/non-occurrence of uncertain future events not wholly within the entity's control; OR (b) a present obligation not recognised because it is NOT PROBABLE an outflow will be required, or the amount cannot be measured reliably.
Contingent asset
A possible asset arising from past events, whose existence will be confirmed only by the occurrence/non-occurrence of uncertain future events not wholly within the entity's control.
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The Provision Recognition Test – Three Conditions
All three conditions must be met
1. Present obligation
A present obligation (legal or constructive) exists as a result of a PAST event.
2. Probable outflow
It is PROBABLE (more likely than not, generally interpreted as >50%) that an outflow of economic benefit-embodying resources will be required to settle the obligation.
3. Reliable estimate
A reliable estimate can be made of the amount of the obligation.
If ANY of these three conditions is NOT met, no provision is recognised – the item is instead assessed as a possible contingent liability (Section 7), disclosed rather than recognised, unless the possibility of an outflow is REMOTE, in which case no disclosure is even required.
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Present Obligation – Legal vs Constructive (with worked example)
Two types of obligation
Legal obligation – derives from a contract, legislation, or other operation of law Constructive obligation – derives from an entity's actions where: (a) by an established pattern of past practice, published policies, or a sufficiently specific current statement, it has indicated to other parties it will accept certain responsibilities; AND (b) as a result, it has created a valid expectation on the part of those other parties that it will discharge those responsibilities
Worked example – a constructive obligation
Example 1: Store's returns policy creates a constructive obligation
A retailer has NO legal obligation to accept returns of faulty goods beyond the statutory minimum, but has a well-known, widely publicised policy of accepting returns for any reason within 90 days, and has consistently honoured this for years. At year end, based on past experience, the retailer estimates $85,000 of goods sold in the last 90 days will be returned.
A CONSTRUCTIVE obligation exists – the retailer's established practice and published policy have created a valid customer expectation, satisfying the present obligation test even without a strict legal requirement. A provision of $85,000 is recognised, based on the reliably estimable expected returns.
This is a classic exam scenario testing whether students recognise that "no legal requirement" does NOT automatically mean "no provision" – constructive obligations are just as real under IAS 37.
5
Measuring a Provision (with worked example)
Key measurement principles
Risks and uncertainties surrounding events/circumstances are taken into account in reaching the best estimate – but uncertainty does NOT justify creating EXCESSIVE provisions or deliberately overstating liabilities Where the effect of the time value of money is MATERIAL, the provision is DISCOUNTED to present value, using a pre-tax rate reflecting current market assessments and risks specific to the liability Future events (e.g. changes in law, new technology) are reflected in the amount of a provision ONLY where there is sufficient objective evidence they will occur Gains from 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
Worked example – expected value calculation
Example 2: Warranty provision using expected value
A manufacturer sells products with a 1-year warranty. Based on past experience: 75% of products have no defects (nil cost), 20% have minor defects (average repair cost $40/unit), and 5% have major defects (average repair cost $200/unit). 10,000 units were sold during the year.
Expected cost per unit = (75% × 0) + (20% × 40) + (5% × 200) = 0 + 8 + 10 = $18/unit
Total warranty provision = 10,000 × $18 = $180,000
Total warranty provision = 10,000 × $18 = $180,000
Dr
Warranty expense $180,000
SOPL
Cr
Warranty provision $180,000
SOFP
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Specific Applications – Restructuring & Onerous Contracts
Restructuring provisions – a strict recognition timing test
A constructive obligation for restructuring arises ONLY when an entity: (a) has a DETAILED FORMAL PLAN identifying the business/part concerned, principal locations affected, function/approximate number of employees to be compensated, expenditures involved, and when the plan will be implemented; AND (b) has raised a VALID EXPECTATION in those affected that it will carry out the restructuring, by starting to implement the plan OR announcing its main features to those affected.
A mere BOARD DECISION to restructure, without communication to those affected, does NOT create a constructive obligation – this is one of the single most heavily tested points in IAS 37.
Onerous contracts – worked example
DEFINITION
A contract in which the UNAVOIDABLE costs of meeting the obligations under it EXCEED the economic benefits expected to be received under it
Example 3: Onerous lease provision
An entity has a non-cancellable lease on a warehouse it no longer uses, with 2 years remaining at $60,000/year, and no realistic prospect of sub-letting.
Provision = present value of unavoidable lease payments over the remaining term = ≈$114,000 (discounted), recognised in full immediately.
7
Contingent Liabilities – Recognition vs Disclosure
The three-tier probability spectrum
Probability of outflowAccounting treatment
PROBABLE (more likely than not) + reliably estimableRECOGNISE a provision
POSSIBLE, but not probableDISCLOSE as a contingent liability (nature, estimate of financial effect, uncertainties)
REMOTENO disclosure required
This spectrum is one of the most fundamental frameworks in the whole of IFRS and is tested extensively across ACCA/professional exams – "probable," "possible," and "remote" each trigger genuinely different treatment.
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Contingent Assets
The mirror-image, more cautious approach
A contingent asset is NOT recognised, since this could result in the recognition of income that may NEVER be realised. A contingent asset IS disclosed where an inflow of economic benefits is PROBABLE. When the realisation of income is VIRTUALLY CERTAIN, the related asset is no longer a contingent asset – it is recognised as a genuine asset (not a contingency at all).
Note the ASYMMETRIC thresholds: LIABILITIES are recognised at "PROBABLE"; ASSETS require "VIRTUALLY CERTAIN" before recognition – a direct, deliberate application of prudence within neutral, unbiased reporting.
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Reimbursements & Subsequent Changes in Provisions
Reimbursements – separate asset recognition, gross presentation
Where some or all of the expenditure to settle a provision is expected to be REIMBURSED by another party (e.g. an insurer), the reimbursement is recognised ONLY when it is VIRTUALLY CERTAIN to be received, as a SEPARATE ASSET – the provision and the reimbursement asset are presented GROSS in the SOFP, NOT netted against each other, though the expense MAY be presented net of the reimbursement in the SOPL.
Review and use of provisions
Provisions are REVIEWED at each reporting date, and adjusted to reflect the current best estimate If it is no longer probable an outflow will be required, the provision is REVERSED A provision is used ONLY for expenditures for which it was ORIGINALLY recognised – a provision for restructuring, for example, cannot be applied against unrelated general expenses
The unwinding of the discount on a provision measured at present value is recognised as a finance/borrowing cost, NOT re-measured as a change in the underlying provision estimate.
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Disclosure Requirements
Required disclosures
FOR EACH CLASS OF PROVISION
Opening and closing carrying amount; additional provisions made; amounts used (i.e. incurred and charged against the provision); unused amounts reversed; the increase during the period from the unwinding of discount and any effect of a change in the discount rate A brief description of the nature of the obligation and expected timing of any resulting outflows An indication of the uncertainties about the amount/timing of those outflows The amount of any expected reimbursement, stating the amount of any asset recognised for that reimbursement
CONTINGENT LIABILITIES / ASSETS
For each class of contingent liability: a brief description, an estimate of its financial effect, an indication of uncertainties, and the possibility of any reimbursement Where an inflow of economic benefits is probable, a brief description of the nature of contingent assets at the reporting date, and an estimate of their financial effect
In EXTREMELY RARE cases, disclosure of some/all of this information can be expected to seriously PREJUDICE the entity's position in a dispute with other parties (e.g. active litigation) – in such cases, disclosure is not required, but the general nature of the dispute must still be disclosed, together with the fact that, and reason why, the information has not been disclosed.
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Critical Judgments & Estimates
Where management judgement matters most
SIGNIFICANT JUDGEMENTS
Whether a present obligation (legal or constructive) genuinely exists at the reporting date Whether an outflow is "probable" (i.e. more likely than not) versus merely "possible" Whether a restructuring plan has been sufficiently communicated to create a valid expectation
SIGNIFICANT ESTIMATES
The expected value or most likely outcome used to measure a provision The discount rate applied where the time value of money is material Litigation outcome probabilities, often relying on legal counsel's assessment
Litigation-related provisions are a particularly sensitive area – management must exercise considerable judgement in balancing genuine best-estimate disclosure against the narrow "prejudicial disclosure" exemption, which is intended to be used only in truly exceptional cases.
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IFRS vs US GAAP – Key Differences
Comparison – IAS 37 vs US GAAP (ASC 450)
FeatureIFRS (IAS 37)US GAAP
Probability threshold for recognition"Probable" generally interpreted as MORE LIKELY THAN NOT (>50%)"Probable" is a HIGHER threshold under US GAAP, generally interpreted as a more stringent likelihood standard than IFRS's >50% reading
Measurement when a range exists, no best estimate within the rangeUses the MID-POINT of the range as the best estimateUses the LOW END of the range if no amount within it is a better estimate than any other
Restructuring provisionsRecognised once a detailed plan exists AND has been communicated/started, creating a valid expectationGenerally requires the LIABILITY to be incurred, often a somewhat stricter/later recognition point in some fact patterns (e.g. certain employee termination costs recognised only when specific US GAAP criteria under ASC 420 are met)
Contingent assetsRecognised only when virtually certain; otherwise disclosed if probableGenerally NOT recognised until realised or realisable – similarly conservative but with its own specific guidance
The "probable" threshold difference and the range-estimate convention (mid-point under IFRS vs low-end under US GAAP where no single best estimate exists) are the most frequently cited practical divergences between the two frameworks for provisions.
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Statement Mapping – Where Every Provision/Contingency Event Lands
Comprehensive event-to-statement mapping table
Event / transactionStatement(s) affectedNotes
Recognition of a new provision (present obligation, probable, reliably estimable)SOPL SOFPExpense/liability recognised in full
Unwinding of discount on a present-valued provisionSOPL SOFPPresented as a finance cost, increasing the provision
Provision used (expenditure incurred against it)SOFPReduces the provision; no further SOPL charge for the amount already provided
Provision no longer required – reversedSOPL SOFPCredited back to profit or loss
Reimbursement virtually certainSOFPRecognised as a SEPARATE asset, presented gross against the provision
Contingent liability – possible but not probable–Not recognised; disclosed in notes only
Contingent liability – remote–Neither recognised nor disclosed
Contingent asset – probable inflow–Not recognised; disclosed in notes
Contingent asset – virtually certainSOFP SOPLNo longer contingent; recognised as a genuine asset/income
Cash payment against a provisionCash Flow StatementOperating activities outflow
Provision movement analysis, contingency descriptionsNotesMandatory reconciliation and disclosure for each class
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Related Standards & Glossary
Related standards – cross-reference map
StandardConnection
IAS 10Events after the reporting period can be ADJUSTING evidence for a provision's existence/measurement at year end
IAS 19Termination benefits arising from a restructuring are recognised alongside the related IAS 37 restructuring provision
IAS 8Changes in provision estimates are treated as changes in accounting estimate, applied prospectively
IAS 16 / IAS 38Provisions for decommissioning/restoration obligations are capitalised as part of the related asset's cost, then depreciated
IFRS 3Contingent liabilities of an ACQUIREE are recognised at fair value in a business combination even if they wouldn't independently meet IAS 37's recognition criteria
IFRS 15Onerous revenue contracts interact with IAS 37's onerous contract provisions where unavoidable costs exceed expected benefits
Quick-reference glossary
Executory contract
A contract under which neither party has performed any of its obligations, or both have partially performed to an equal extent – generally outside IAS 37's scope unless onerous.
Onerous contract
A contract in which the unavoidable costs of meeting the obligations exceed the economic benefits expected to be received.
Constructive obligation
An obligation derived from an entity's actions, established pattern of practice, or published policies, creating a valid expectation in others that it will discharge certain responsibilities.
Financial statement key
BS Balance sheet
IS Income statement
SE Statement of changes in equity
OCI Other comprehensive income
SCF Statement of cash flows
History & Development
Aug-1997
Exposure Draft E59 Provisions, Contingent Liabilities and Contingent Assets published
Sep-1998
IAS 37 Provisions, Contingent Liabilities and Contingent Assets issued
Operative for annual financial statements covering periods beginning on or after 1 July 1999
30-Jun-2005
Exposure Draft Amendments to IAS 37 Provisions, Contingent Liabilities and Contingent Assets and IAS 19 Employee Benefits published
Comment deadline 28 October 2005 (proposals were not finalised, instead being reconsidered as a longer term research project)
14-May-2020
Amended by Onerous Contracts - Cost of Fulfilling a Contract (Amendments to IAS 37)
Effective for annual periods beginning on or after 1 January 2022