Provisions and events after the reporting period: formula sheet

Key formulas

Recognition criteria for a provision

Present obligation (legal or constructive) from a past event AND outflow probable AND reliable estimate

All three must be met. If any one fails, no provision is recognised.

Meaning of probable

Probable = more likely than not (above 50%)

Used for recognising provisions, both for whether a present obligation exists and for whether an outflow is probable. It is also used for disclosing contingent assets.

Provision decision

All three criteria met → recognise provision

Debit the expense (or asset where applicable), credit provision liability.

Contingent liability treatment

Possible obligation, or present obligation failing recognition → disclose unless outflow is remote

No entry in the statement of financial position.

Contingent asset treatment

Inflow probable → disclose; inflow virtually certain → recognise as an asset; otherwise → ignore

Be prudent: gains are recognised later than losses.

Expected value

Expected value = Σ (probability × outcome)

Use for a large population of similar items. Probabilities must add to 100%.

Present value of a provision

PV = future cash outflow ÷ (1 + r)ⁿ

r is the pre-tax discount rate and n is the number of years until settlement. Discount only if the effect is material.

Unwinding of discount

Finance cost for the year = opening provision × discount rate

Charge to profit or loss as a finance cost and add to the provision.

Single obligation

Best estimate ≈ most likely outcome

Adjust upwards or downwards if other possible outcomes are mostly higher or lower.

Reimbursement

Asset recognised only if virtually certain, and ≤ provision

Present the asset separately from the provision in the statement of financial position.

Recognition test

Present obligation + past event + probable outflow (> 50%) + reliable estimate → provision

All conditions must be met. If the outflow is only possible, disclose a contingent liability.

Restructuring provision

Direct restructuring costs only (e.g. redundancy) once a detailed formal plan exists and a valid expectation is raised

Exclude retraining, relocation of continuing staff, marketing and new systems.

Onerous contract provision

Provision = lower of (cost of fulfilling the contract − benefits) and exit penalty

Fulfilling cost is the unavoidable costs net of expected benefits. Test dedicated assets for impairment first.

Warranty expected value

Expected cost = Σ (probability × cost of each outcome)

Use for a large population of similar items. For a single item, use the most likely outcome.

Decommissioning

Dr Asset (PV of cost) Cr Provision (PV of cost); each year Dr Finance cost, Cr Provision (unwinding)

PV = future cost ÷ (1 + r)^n. The asset is then depreciated over its useful life.

Period covered

Reporting date → date financial statements are authorised for issue

Events outside this window are not IAS 10 events.

Adjusting event

Evidence of a condition existing at the reporting date → adjust recognised amounts

Examples: customer insolvency on an existing receivable, inventory NRV evidence, settlement of a court case for an existing obligation.

Non-adjusting event

Condition arose after the reporting date → no adjustment; disclose nature and estimated financial effect if material

If the effect cannot be estimated, say so.

Dividends

Dividends declared after the reporting date → not a liability at the reporting date

Disclose only. Do not accrue.

Going concern

Decision to liquidate or cease trading, or no realistic alternative, after the reporting date → do not use going concern basis

A serious deterioration in operating results and financial position after the reporting date may show going concern is no longer appropriate. The change affects the whole set of statements, not just some figures.

Quick revision

• A provision is a liability of uncertain timing or amount.
• Recognise a provision only if there is a present obligation from a past event, an outflow is probable, and a reliable estimate can be made.
• A present obligation can be legal or constructive.
• Probable means more likely than not.
• A contingent liability is disclosed, not recognised, unless the outflow is remote.
• A contingent asset is disclosed only when an inflow is probable and is recognised only when it is virtually certain.
• Use the best estimate: the most likely outcome for one item, expected value for many items.
• Discount the provision when the time value of money is material, and charge the unwinding as a finance cost.
• Do not provide for future operating losses or for costs that can be avoided by future action.
• A restructuring provision needs a detailed formal plan and a valid expectation in those affected, such as a announcement or start of implementation.
• An onerous contract provision is the lower of the cost of exiting and the cost of fulfilling the contract.
• Adjusting events give further evidence of conditions at the reporting date; non-adjusting events relate to conditions arising afterwards and are disclosed if material.
• Dividends declared after the reporting period are not recognised as a liability at the reporting date.

Common mistakes

• Providing for future operating losses or planned future costs. Fix: Check for a present obligation from a past event. Future operating losses have none, so no provision is made.
• Recognising a provision for a possible (not probable) outflow. Fix: Probable means more likely than not. If it is merely possible, disclose a contingent liability instead.
• Using the most likely outcome for a large population such as warranties. Fix: Whenever the question mentions many units or claims, calculate the expected value across all outcomes.
• Providing for future operating losses. Fix: Remember there is no present obligation from a past event. Only onerous contracts are an exception, and that is a separate rule.
• Providing for restructuring because the board approved a plan before year end. Fix: Look for a detailed plan plus announcement or start of implementation before the reporting date. No communication means no constructive obligation.
• Including retraining, relocation or marketing costs in a restructuring provision. Fix: Include only direct costs necessarily entailed by the restructuring and not associated with ongoing activities. Redundancy is in; future-operation costs are out.
• Treating a dividend declared after the year end as a liability. Fix: A liability needs a present obligation at the reporting date. A dividend declared afterwards creates none. Disclose it in the notes.
• Classifying a fall in the market value of investments after the year end as adjusting. Fix: The fall reflects market conditions arising after the year end. It is non-adjusting, so you disclose it if material.

Exam tips

• In Section B scenarios, underline the words 'probable', 'possible' and 'virtually certain'. The answer usually turns on one of them.
• Use the exact IAS 37 labels in written answers: present obligation, past event, probable outflow, reliable estimate.
• Always give the journal when a provision is recognised, and the disclosure wording when it is not. Examiners award marks for both.
• Watch for traps: a board decision to restructure, future repairs or future losses often have no present obligation.
• Objective test questions are marked all or nothing: a wrong answer scores zero and there are no part marks. Separately, work through the three tests in order so you reach the right answer.
• Read the scenario for the word 'population' or a list of probabilities. That signals expected value.
• In Section A, a possible reimbursement is usually a trap. Check whether it is virtually certain before including an asset.
• In Section C, set out the discount working clearly, even if you slip on arithmetic. Marks go for method, such as the correct rate and years.