Liabilities and equity

IAS 37 · Provisions and contingencies

Probable: recognise. Possible: disclose. Remote: nothing.

Draft: not yet reviewed by a teacher

Why it exists

A business often knows it will have to pay without knowing exactly how much or when: warranty repairs, a customer's lawsuit. Waiting for the bill would overstate this year's profit. The standard says when such a future payment is already a liability and when it is only information for users.

Key rules

A provision is a liability of uncertain timing or amount.
Recognise it when (1) there is a present obligation (legal or constructive) from a past event, (2) an outflow of resources is probable (more likely than not), and (3) a reliable estimate can be made.
A contingent liability (a possible outflow) is not recognised but disclosed in the notes; if the outflow is remote, nothing is disclosed.
A contingent asset: disclose if an inflow is probable; if it is virtually certain, it is a normal asset; otherwise nothing.
Measure at the best estimate of the cost to settle: for many small cases (warranties) use the expected value.
The year's movement goes to profit or loss: Dr Expense, Cr Provision for an increase, the reverse for a decrease.
A single obligation (a lawsuit) is measured at the most likely outcome. If the time value of money is material, the provision is discounted at a pre-tax rate; the yearly unwinding of the discount is a finance cost (the financing category under IFRS 18).
Decommissioning and restoration: the present value of the obligation is added to the asset's cost (IAS 16: Dr PPE, Cr Provision) and depreciated with it.
Onerous contract: provide for the least net cost of exiting, the lower of (cost of fulfilling − revenue) and the penalty for leaving. Cost of fulfilling = incremental costs + an allocation of other directly related costs.
Restructuring: a provision only with a detailed formal plan and a valid expectation (started or announced before the reporting date); it includes only direct costs not associated with the continuing activities.

Examples

A Bakı air-conditioner seller sold 2,000 units in 2026 with a one-year warranty. Experience: 5% come back and a repair costs 120. The opening provision was 9,500.

Closing provision: 2,000 × 5% × 120 = 12,000
Increase in the year: 12,000 − 9,500 = 2,500
Entry: Dr Warranty expense 2,500, Cr Warranty provision 2,500
Statement of financial position: a liability of 12,000

A warranty provision and its movement

A drilling rig comes into use on 1 January 2026; construction cost 58,425 (AZN '000). It must be removed after 10 years at a cost of 25,000; the rate is 8% and the discount factor 0.463.

Provision: 25,000 × 0.463 = 11,575; Dr PPE 11,575, Cr Provision 11,575
Rig cost: 58,425 + 11,575 = 70,000; depreciation 7,000 a year
Unwinding for 2026: 11,575 × 8% = 926, a finance cost
At 31.12.2026: provision 12,501, rig 63,000

A discounted decommissioning provision (FR)

How it works

Probability and measurability decide:

probable and measurable: a provision in the statement of financial position;
possible: a note on the contingent liability;
remote: nothing.

For assets the bar is higher, out of prudence: a contingent asset is disclosed only when an inflow is probable and recognised only when it is virtually certain.

Traps

Taught in the course

Key rules

A provision is a liability of uncertain timing or amount.

Recognise it when (1) there is a present obligation (legal or constructive) from a past event, (2) an outflow of resources is probable (more likely than not), and (3) a reliable estimate can be made.

A contingent liability (a possible outflow) is not recognised but disclosed in the notes; if the outflow is remote, nothing is disclosed.

A contingent asset: disclose if an inflow is probable; if it is virtually certain, it is a normal asset; otherwise nothing.

Measure at the best estimate of the cost to settle: for many small cases (warranties) use the expected value.

The year's movement goes to profit or loss: Dr Expense, Cr Provision for an increase, the reverse for a decrease.

A single obligation (a lawsuit) is measured at the most likely outcome. If the time value of money is material, the provision is discounted at a pre-tax rate; the yearly unwinding of the discount is a finance cost (the financing category under IFRS 18).

Decommissioning and restoration: the present value of the obligation is added to the asset's cost (IAS 16: Dr PPE, Cr Provision) and depreciated with it.

Onerous contract: provide for the least net cost of exiting, the lower of (cost of fulfilling − revenue) and the penalty for leaving. Cost of fulfilling = incremental costs + an allocation of other directly related costs.

Restructuring: a provision only with a detailed formal plan and a valid expectation (started or announced before the reporting date); it includes only direct costs not associated with the continuing activities.