Ensure appropriate recognition criteria and measurement bases are applied to provisions, contingent liabilities, and contingent assets.
Require sufficient disclosure in the notes to enable users to understand their nature, timing, and amount.
IAS 37 Provisions, Contingent Liabilities and Contingent Assets
IFRS Summaries by Imad Uddin, FRM
Objective
Scope
IAS 37 applies to all entities in accounting for all provisions, contingent liabilities, and contingent assets, except:
Those resulting from executory contracts, unless the contract is onerous (loss-making).
Those covered by another IFRS Standard. Examples include:
Contracts within scope of IFRS 15 *Revenue*.
Income taxes (IAS 12).
Leases (IFRS 16) - but IAS 37 applies to onerous operating leases.
Employee benefits (IAS 19).
Insurance contracts (IFRS 17).
Financial instruments within scope of IFRS 9.
Key Definitions
| Term | Meaning |
|---|---|
| Provision | A liability of uncertain timing or amount. |
| Liability | A present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. |
| Obligating Event | An event that creates a legal or constructive obligation that results in an entity having no realistic alternative to settling that obligation. |
| Legal Obligation | An obligation that derives from: (a) a contract; (b) legislation; or (c) other operation of law. |
| Constructive Obligation | An obligation that derives from an entity's actions where: (a) by an established pattern of past practice, published policies or a sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities; and (b) as a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities. |
| Contingent Liability | (a) A possible obligation arising from past events whose existence will be confirmed only by uncertain future events not wholly within the entity's control; OR (b) A present obligation arising from past events but not recognized because: (i) it is not probable an outflow will be required, or (ii) the amount cannot be measured with sufficient reliability. |
| Contingent Asset | A possible asset arising from past events whose existence will be confirmed only by uncertain future events not wholly within the entity's control. |
Recognition Criteria
Provisions:
Recognize a provision if, and only if, ALL three conditions are met:
The entity has a present obligation (legal or constructive) as a result of a past event (the obligating event).
It is probable (i.e., more likely than not) that an outflow of resources embodying economic benefits will be required to settle the obligation.
A reliable estimate can be made of the amount of the obligation.
If these conditions are not met, no provision is recognized.
Contingent Liabilities:
A contingent liability is NOT recognized in the financial statements.
It is disclosed in the notes (see Disclosures), unless the possibility of an outflow of resources is remote.
Contingent Assets:
A contingent asset is NOT recognized in the financial statements (to avoid recognizing income that may never be realized).
It is disclosed in the notes where an inflow of economic benefits is probable.
When the realization of income is virtually certain, then the related asset is no longer contingent and its recognition is appropriate (and required by other standards).
Measurement of Provisions
The amount recognized as a provision should be the best estimate of the expenditure required to settle the present obligation at the end of the reporting period.
Best estimate involves judgment and considers:
Weighted average of outcomes (if large population of items).
Most likely outcome (if single obligation).
Risks and uncertainties surrounding the amount or timing of outflows must be considered.
Where the effect of the time value of money is material, the amount of the provision should be the present value of the expected expenditures. The discount rate should be a pre-tax rate reflecting current market assessments of time value and risks specific to the liability.
Future events (e.g., changes in technology, legislation) that may affect the settlement amount are reflected in the estimate if there is sufficient objective evidence they will occur.
Gains from the expected disposal of assets are not taken into account when measuring a provision.
Reimbursements from third parties (e.g., insurance claims, supplier warranties) are recognized only when receipt is virtually certain. Recognized as a separate asset, not netted against the provision. The expense related to the provision may be presented net of the reimbursement in P&L.
Provisions must be reviewed at each reporting date and adjusted to reflect the current best estimate. If outflow no longer probable, reverse the provision.
Specific Applications
Onerous Contracts:
An onerous contract is one where the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it.
Unavoidable costs = Lower of (Cost of fulfilling the contract) and (Compensation/penalties from failure to fulfil).
If a contract is onerous, the present obligation under the contract is recognized and measured as a provision.
Before establishing a provision, first recognize any impairment loss on assets dedicated to that contract (IAS 36).
Restructuring:
A restructuring is a programme planned and controlled by management that materially changes the scope of business or the manner in which business is conducted (e.g., sale/termination of line of business, closure of locations, fundamental reorganization).
A provision for restructuring costs is recognized only when the general recognition criteria for provisions are met. A constructive obligation arises only when the entity:
Has a detailed formal plan identifying key features (business affected, locations, employees affected/compensation, expenditures, timing); AND
Has raised a valid expectation in those affected that it will carry out the restructuring by either starting implementation or announcing main features.
A restructuring provision includes only direct expenditures arising from the restructuring, which are both:
Necessarily entailed by the restructuring; AND
Not associated with the ongoing activities of the entity (e.g., excludes retraining/relocating staff, marketing, investment in new systems).
Disclosures
For Each Class of Provision:
Reconciliation showing: Carrying amount at beginning and end; Additions during period; Amounts used (charged against provision); Unused amounts reversed; Increase due to passage of time (discount unwinding) & effect of change in discount rate. (Comparative info not required).
Brief description of the nature of the obligation and expected timing of outflows.
Indication of uncertainties about amount or timing of outflows. Major assumptions made concerning future events.
Amount of any expected reimbursement, stating amount of any asset recognized for it.
For Each Class of Contingent Liability (unless outflow remote):
Brief description of its nature.
Estimate of its financial effect (measured per IAS 37).
Indication of uncertainties relating to amount or timing.
Possibility of any reimbursement.
If impracticable to disclose estimate/uncertainties, state that fact.
For Each Class of Contingent Asset (where inflow probable):
Brief description of its nature.
Estimate of its financial effect (measured per IAS 37).
If impracticable, state that fact. Avoid misleading indications of likelihood of income arising.
In extremely rare cases where disclosure can be expected to seriously prejudice the entity's position in a dispute, limited disclosure is permitted, but general nature, fact of non-disclosure, and reason must be given.
Summary Table - Recognition & Disclosure
| Aspect | Requirement / Treatment |
|---|---|
| Provision Recognition | Recognize IF: Present obligation (past event) + Probable outflow + Reliable estimate. |
| Contingent Liability | Do NOT recognize. Disclose unless outflow possibility is remote. |
| Contingent Asset | Do NOT recognize. Disclose if inflow is probable. Recognize asset only when inflow is virtually certain. |
| Provision Measurement | Best estimate of settlement expenditure. Consider risks/uncertainties. Discount if time value material. |
| Onerous Contracts | Recognize provision for unavoidable costs exceeding expected benefits. |
| Restructuring | Recognize provision only when detailed formal plan exists AND valid expectation raised in those affected. Include only direct costs. |
| Disclosures | Detailed reconciliation & description for provisions. Description & estimate (if possible) for contingent liabilities/assets (unless remote). |
Key Judgments and Estimates
Determining whether a present obligation (legal or constructive) exists as a result of a past event.
Assessing the probability ('more likely than not') of an outflow (for provisions) or inflow (for contingent assets).
Estimating the amount of the obligation (the 'best estimate'), incorporating risks, uncertainties, and potentially discounting.
Identifying whether a contract has become onerous.
Evaluating whether the criteria for recognizing a restructuring provision have been met (formal plan + valid expectation).
Assessing the likelihood of reimbursements ('virtually certain').
Disclaimer: These IFRS summaries are provided for educational purposes only.
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Imad Uddin is deeply passionate about IFRS and has founded Analyqt, a consulting firm dedicated to helping clients navigate complex accounting and financial reporting challenges. In addition to his advisory work, Imad is committed to education and knowledge-sharing, which led to the creation of IFRSMasterclass.com, a platform offering high-quality IFRS training and resources.
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