Distinguish provisions from contingent items under IAS 37
Apply the present-obligation, probable-outflow and reliable-estimate tests before recognizing a provision or disclosing uncertainty.
Section 3.2 · Regulatory and ethical considerations
Cambridge International AS & A Level Accounting 9706, 2026–2028 syllabus, Version 2. These lessons cover the nine named IAS at the main-provisions level described in Cambridge teacher guidance, the stated ethical principles, audit and stewardship. Practice is self-checked, not an official Cambridge grade. Full timed Papers 1–4 and human subject-teacher review remain outstanding.
Before you begin
- Use the Topic 1.5 and 3.1 statement skills: identify the reporting period, distinguish profit from cash, and explain how a reporting choice affects users of financial statements.
Work on paper. Try each question before revealing help, and explain why your method works.
Quick readiness check
A company announces a future factory upgrade but has not ordered equipment or entered a contract. Is there automatically a provision?
What you will learn
- Apply all three provision recognition criteria
- Distinguish a provision from a contingent liability
- Explain why a contingent asset is not recognized merely because recovery is possible
Recognise a provision only for a present obligation
A provision is a liability of uncertain timing or amount. Recognise one only when there is a present legal or constructive obligation from a past event, an outflow of resources is probable, and the amount can be estimated reliably. The amount is the best estimate of the expenditure needed to settle the obligation at the reporting date.
A constructive obligation can arise from a business's established actions or policies that create a valid expectation that it will accept a responsibility. A plan for future spending, without a present obligation created by a past event, is not by itself a provision.
Disclose uncertainty without overstating certainty
A contingent liability is a possible obligation depending on an uncertain future event, or a present obligation that is not recognised because an outflow is not probable or the amount cannot be measured reliably. It is generally disclosed unless the possibility of an outflow is remote, with the required nature and uncertainty explained.
A contingent asset is possible, not yet sufficiently certain to recognise. Do not record a gain just because a claim may succeed. Disclosure is considered when an inflow is probable; recognition waits until the inflow is virtually certain under the standard. Keep the syllabus focus on the recognition distinction rather than specialist legal prediction.
Pause and explain
A present obligation exists, but outflow is not probable. What is the usual broad treatment?
Worked example
A company sells goods with a warranty. Past experience supports an expected repair cost of $18,000 and the obligation arises from sales made before year end. Explain the broad IAS 37 treatment.
Show the worked solution
- The sale has already occurred and the warranty creates a present constructive or contractual obligation.
- An outflow for repairs is probable based on experience and can be estimated reliably.
- Recognise a provision using the best estimate, with the specific amount supported by the case facts.
Answer Recognise a warranty provision of $18,000 if the stated evidence supports a present obligation, probable outflow and reliable estimate.
Try a topic test
Choose Easy, Normal or Difficult. Save your answers and open worked review after finishing.
Test this topic →From guided practice to a new situation
Write your answer and reasoning first. Use a hint only if you are stuck. The model solution is for self-checking; your written work is not automatically marked.
A retailer faces a claim from a past sale. Lawyers say loss is possible but not probable; the amount could be estimated. Classify the item and state the broad treatment.
Give me a hint
Test obligation, probability and reliable measurement separately.
Compare my reasoning
- A past sale may give rise to a possible obligation, but the case says loss is not probable.
- The probable-outflow condition for recognising a provision is not met.
- Treat as a contingent liability and disclose unless the possibility of outflow is remote.
Do not recognise a provision on these facts. Disclose the contingent liability unless the possibility of outflow is remote.
Look for these in your work
- Recognition criteria checked
- Provision not overstated
- Disclosure exception noted
A company has a present legal obligation estimated at $42,000. Payment is probable and the amount is reliable. State the amount recognized and why it is a provision.
Give me a hint
Use the best estimate supported by the stated information.
Compare my reasoning
- A present legal obligation results from a past event.
- Outflow is probable and $42,000 can be estimated reliably.
- Recognise a provision at the best estimate of $42,000, subject to any further case facts relevant to measurement.
Recognise a $42,000 provision because all three stated recognition criteria are met.
Look for these in your work
- Obligation from past event
- Probable outflow
- Reliable estimate
A company expects to pay for retraining next year after replacing machinery. No current contract or promise requires it to retrain staff. Explain why a provision is not automatically appropriate.
Give me a hint
A likely future expense is not enough; identify a present obligation created by a past event.
Compare my reasoning
- The company expects future spending, but an intention or forecast alone does not show a present legal or constructive obligation.
- Check whether a past action or established policy has created a valid expectation that the company has accepted responsibility.
- If no present obligation exists, do not recognize a provision; account for the expense when the relevant service or obligation arises.
Future retraining plans alone do not meet the present-obligation criterion. Recognize no provision unless past events created a legal or constructive obligation; review again when the service or obligation arises.
Look for these in your work
- Forecast separated from obligation
- Constructive obligation considered
- No unsupported liability
Common mistakes
- Providing for future operating losses or planned spending without a present obligation
- Recognising every possible lawsuit as a provision
- Recording a contingent asset before the inflow is virtually certain
What can you explain now?
Name the three conditions for recognising a provision.
Compare with the explanation
Present obligation from a past event, probable outflow and reliable estimate
All three recognition criteria are needed; a possible future cost alone is insufficient.
After trying it yourself, choose your next review. This is your self-assessment.
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Make it stick
State the three provision criteria and the key recognition threshold for a contingent asset.
If you needed the solution, close it and solve the problem again from a blank page. A correct answer is stronger when you can explain the reason for each step.