IAS 37

IAS 37 Provisions, Contingent Liabilities and Contingent Assets is the standard in International Financial Reporting Standards that governs how an entity accounts for obligations whose timing or amount is uncertain. It defines a provision as a liability of uncertain timing or amount, sets the conditions under which one must be recognised, and explains how it is measured. It also defines contingent liabilities and contingent assets, which are disclosed in the notes and not recognised in the statement of financial position.

The standard was issued in 1998 and took effect in 1999. A main purpose was to end the practice of creating large general provisions in good years and releasing them later to smooth profits. It does not apply to items covered by other standards, such as income taxes, employee benefits, insurance contracts, leases other than onerous ones, and financial instruments including expected credit loss allowances.

A provision is recognised only when three conditions are all met.

• A present obligation exists as a result of a past event. The obligation may be legal, arising from a contract or legislation, or constructive, arising where the entity's established practice or published policies have created a valid expectation in others that it will meet certain responsibilities.
• An outflow of resources is probable. Probable means more likely than not.
• A reliable estimate can be made of the amount of the obligation.

The past event must leave the entity with no realistic alternative to settling. Costs that need to be incurred to operate in future do not qualify, so no provision is made for future operating losses or for an intention to incur expenditure that the entity could still avoid.

The amount recognised is the best estimate of the expenditure required to settle the obligation at the end of the reporting period. For a large population of items, such as product warranties, the estimate is an expected value, weighting each possible outcome by its probability. For a single obligation, the individual most likely outcome may be the best estimate, adjusted where other outcomes are mostly higher or mostly lower.

Where the effect of the time value of money is material, the provision is the present value of the expected expenditure, using a pre-tax discount rate. The increase in the provision as the discount unwinds is recognised as a finance cost. Provisions are reviewed at each reporting date and adjusted to the current best estimate, and they may be used only for the expenditure for which they were originally set up. Where another party is expected to reimburse some of the cost, for instance an insurer, the reimbursement is recognised as a separate asset only when it is virtually certain to be received.

A contingent liability is either a possible obligation whose existence will be confirmed only by uncertain future events not wholly within the entity's control, or a present obligation that fails the recognition tests because an outflow is not probable or cannot be measured reliably. It is not recognised but is disclosed, unless the possibility of an outflow is remote. A typical example is a legal claim that the entity's lawyers believe it will probably defend successfully.

A contingent asset is a possible asset arising from past events, such as a claim the entity is pursuing. It is not recognised, since that could mean recording income that may never be realised, and is disclosed only where an inflow of benefits is probable. When realisation becomes virtually certain, the asset is no longer contingent and is recognised.

An onerous contract is one in which the unavoidable costs of meeting the obligations exceed the economic benefits expected. The present obligation under it is recognised as a provision, measured at the lower of the cost of fulfilling the contract and the cost of exiting it. An amendment effective from 2022 specified that the cost of fulfilling includes both incremental costs and an allocation of other directly related costs.

A restructuring provision is recognised only when the entity has a detailed formal plan and has raised a valid expectation in those affected, by starting to carry out the plan or announcing its main features. A board decision alone is not enough. The provision covers only direct expenditure arising from the restructuring, not the cost of retraining or relocating continuing staff or of future operations. Obligations to dismantle assets and restore sites are provided for when the damage is caused, with the cost added to the related asset. Levies imposed by governments are covered by an interpretation, IFRIC 21, which identifies the activity that triggers payment as the obligating event. A product warranty liability is the most familiar everyday provision.

A tax provision is not within IAS 37, despite its name; it is governed by the standard on income taxes.

US rules on a loss contingency also require a probable loss that can be estimated, but "probable" is read as a higher likelihood than "more likely than not". Where there is a range of equally likely outcomes, US rules accrue the low end, while IAS 37 uses the mid-point, and discounting is required less often. The International Accounting Standards Board has an active project to make targeted improvements to the standard.

• IFRS Foundation