IAS 37 Provisions: Recognition, Measurement and Disclosures

Under IAS 37, provisions are liabilities of uncertain timing or amount, and you recognize one only when a past event has created a present obligation, an outflow of resources to settle it is probable, and the amount can be reliably estimated. Miss any of the three tests and the item stays off the balance sheet, either as a contingent liability in the notes or as nothing at all. The standard then dictates how to measure the provision, when to discount it, and what has to appear in the disclosures.¹

The Three Recognition Tests

A provision is not the same as a trade payable or an accrual. With a payable, the amount and the due date are both known. With a provision, one or both are uncertain. That uncertainty is why IAS 37 imposes a gate before anything hits the balance sheet.

A Present Obligation From a Past Event

At the reporting date, the entity must have no realistic alternative to settling. The obligation can be legal or constructive. A legal obligation flows from a contract, legislation, or other operation of law: a mining company required by statute to restore a site has a legal obligation the moment the damage occurs. A constructive obligation arises when the entity’s own conduct has created a legitimate expectation in others that it will follow through, typically through an established pattern of past behavior, a published policy, or a sufficiently specific public statement. A retailer with a long-standing, well-publicized practice of accepting returns beyond the statutory period has created a constructive obligation to honor those returns, even without a law compelling it.

A Probable Outflow of Resources

“Probable” in IAS 37 means more likely than not, a threshold understood as exceeding 50%. If the chance of an outflow sits at 50% or lower, the item is a contingent liability rather than a recognized provision.¹ The assessment uses all evidence available at the reporting date.

A Reliable Estimate

The entity must be able to produce a reasonable figure. Absolute precision is not the standard; a range of outcomes that supports a faithful estimate is enough. Where uncertainty is so extreme that no useful estimate can be made, the item cannot be recognized and instead requires contingent liability disclosure.

What You Cannot Provision For

Expected future operating losses fail the first test. At the reporting date, no past event has created an obligation; the losses relate to the entity’s continuing future operations. No provision is permitted.¹

Restructuring is the other area where entities commonly overreach. A constructive obligation to restructure exists only when the entity has a detailed formal plan and has raised a valid expectation in the affected parties, either by starting to carry the plan out or by publicly announcing its main features.² The formal plan must identify the business or business unit and the principal locations affected, the approximate number of employees to be terminated together with their roles and specific costs, and a timeline that begins promptly and ends within a realistic, defined period.

Only costs arising directly from the restructuring qualify. Retraining staff, launching new marketing, or investing in replacement systems relate to future operations and stay out of the provision.²

Onerous Contracts

Executory contracts (where neither party has performed, or both have performed equally) sit outside IAS 37 unless they become onerous. A contract is onerous when the unavoidable costs of meeting the entity’s obligations exceed the economic benefits expected from it. At that point, IAS 37 requires a provision for the expected loss.³

Unavoidable costs are the lower of the cost of fulfilling the contract or the penalties and compensation payable for exiting it. A contract that can be cancelled without cost is not onerous. A classic example: a long-term lease on office space the entity has vacated but cannot terminate, where remaining rent may exceed any sublease income.

A 2022 amendment clarified that the “cost of fulfilling” a contract includes both the incremental costs directly tied to the contract, such as labor and materials, and a fair allocation of other costs that relate directly to fulfilling it, such as depreciation on equipment used in performance. Before recognizing the provision, the entity must first test any assets dedicated to the contract for impairment.

Measuring the Provision

The amount recognized is the best estimate of what it would cost to settle the obligation at the reporting date. Best estimate means what a rational entity would pay to settle it or transfer it to a third party. How the number is built depends on what the provision covers.

Expected Value or Most Likely Outcome

When a provision covers a large population of similar items, such as warranty claims across thousands of units, use the expected value method: weight each possible outcome by its probability and add them together.³ A 60% probability of loss produces a different provision than a 90% probability.

For a single obligation, the most likely individual outcome is often the best estimate. But if the other possible outcomes cluster mostly higher or mostly lower than that figure, the provision must be adjusted. The standard’s example is a plant defect: the most likely outcome may be a successful first repair costing 1,000, but if there is a real chance additional attempts will be needed, the provision should be larger than 1,000.³

Discounting Long-Dated Provisions

When the gap between recognition and expected settlement is material, the provision must be discounted to present value. This matters most for environmental restoration, decommissioning, and other obligations that settle years or decades out. Failing to discount overstates the liability.¹

The rate is a pre-tax rate reflecting the current market view of the time value of money, plus any risks specific to the liability not already built into the cash flow estimates. As settlement approaches, the provision grows. That growth flows through profit or loss as a finance cost, commonly labeled the unwinding of the discount.

Expected Reimbursements

Where a third party, often an insurer, is expected to reimburse part or all of the settlement cost, the reimbursement can be recognized as a separate asset only when receipt on settlement is virtually certain. That is a higher bar than the “more likely than not” threshold used for the provision itself.¹ Even when recognized, the reimbursement asset cannot exceed the related provision. The income statement expense may be shown net of the reimbursement, but the notes must show both gross figures.

Reviewing Provisions Each Period

Every provision must be reviewed at the end of each reporting period and adjusted to the current best estimate. If an outflow is no longer probable, the provision is reversed in full.³ A provision can only be used for the expenditure it was originally set up to cover. Absorbing unrelated costs against it would obscure what different expenses actually represent.

When the Item Is Contingent Instead

Contingent items are the obligations and potential assets that fail the recognition tests. They stay off the balance sheet, but they are not always invisible.

A contingent liability is either a possible obligation whose existence depends on uncertain future events, or a present obligation that fails recognition because the outflow is not probable or the amount cannot be reliably measured. If the chance of an outflow is possible but not remote, the entity discloses the contingent liability in the notes. If remote, no disclosure is required.¹

Contingent assets receive stricter treatment. They are never recognized on the balance sheet, which prevents entities from booking income before it is genuinely assured. Disclosure is permitted only when the inflow of economic benefits is probable. Once the inflow is virtually certain, it stops being contingent and becomes a recognized asset.

Required Disclosures

For each class of provision, the notes must include a reconciliation of the carrying amount movement during the period, covering:

New provisions added.
Amounts used against the provision during the period.
Unused amounts reversed.
The increase from unwinding the discount.

Beyond the reconciliation, the notes must describe the nature of the obligation, the expected timing of any outflows, the significant uncertainties surrounding those outflows, and the amount of any expected reimbursement.¹

Contingent liabilities requiring disclosure need a description of the contingency, an estimate of the financial effect where practicable, notes on the uncertainties around amount and timing, and an indication of any expected reimbursement. Contingent assets that meet the disclosure threshold need a description and, where practicable, an estimate of the financial effect. Where any of this information is impracticable to provide, the entity must say so explicitly.

The Prejudicial Information Exemption

In extremely rare cases, disclosing the required information could seriously damage the entity’s position in a dispute. The entity may then withhold the specific details but must still disclose the general nature of the dispute and explain why the information has been omitted.³ The standard is explicit that this applies only in extreme circumstances, not as a convenient way to keep quiet.

What IAS 37 Does Not Cover

Several categories of obligation that might look like provisions are handled by other standards. Employee benefits fall under IAS 19,⁴ deferred tax under IAS 12,⁵ insurance contracts under IFRS 17,⁶ and obligations arising from financial instruments under IFRS 9.⁷ Where one of those standards applies, IAS 37 steps aside.

1
IFRS Foundation. IAS 37 Provisions, Contingent Liabilities and Contingent Assets
2
GOV.UK. Restructuring Costs and Revenue Recognition
3
IFRS Foundation. International Accounting Standard 37 Provisions, Contingent Liabilities and Contingent Assets
4
IFRS Foundation. International Accounting Standard 19 Employee Benefits
5
IFRS Foundation. IAS 12 Income Taxes
6
IFRS Foundation. IFRS 17 Insurance Contracts
7
IFRS Foundation. IFRS 9 Financial Instruments