Provisions, contingencies and events after the reporting period: formula sheet

Key formulas

Recognition test

Present obligation (legal or constructive) from a past event AND outflow probable (more likely than not) AND reliable estimate = recognise a provision

All three conditions must be met. If not, consider a contingent liability disclosure unless an outflow is remote.

Expected value (large population)

Provision = Σ (probability × cost of each outcome)

Use for a large population of similar items such as warranties or returns. Probabilities must sum to 100%.

Single obligation

Provision = most likely outcome, adjusted if other outcomes are mostly higher or mostly lower

Used for one-off items such as a lawsuit. Do not blindly use the expected value.

Present value

PV = future cash outflow ÷ (1 + r)^n

r is a pre-tax discount rate reflecting the time value of money and risks specific to the liability. Discount only if the effect is material.

Unwinding of discount

Finance cost for year = opening provision × discount rate

Debit finance cost, credit provision. The provision grows to the undiscounted amount by the settlement date.

Reimbursement

Separate asset recognised only if receipt is virtually certain; asset ≤ provision

Present gross in the statement of financial position. The statement of profit or loss may show the expense net of the reimbursement.

Contingent liability: recognition

Not recognised in the statement of financial position

Applies to possible obligations, and to present obligations where outflow is not probable or the amount cannot be measured reliably.

Contingent liability: disclosure

Disclose unless the possibility of outflow is remote

Give a brief description, an estimate of financial effect, the uncertainties on amount or timing, and the possibility of reimbursement, where practicable.

Contingent asset: recognition and disclosure

Inflow virtually certain → recognise as an asset; inflow probable → disclose; otherwise → no disclosure

Virtually certain is a much higher threshold than probable.

Provision test

Present obligation + probable outflow + reliable estimate → recognise

If any one test fails, you have a contingent liability or nothing.

Business combination

Acquiree contingent liability: recognise at acquisition-date fair value if a present obligation and reliably measurable

Probability of outflow is not required. Acquiree contingent assets are not recognised.

Reimbursements

Reimbursement recognised as a separate asset only when virtually certain

The provision is shown gross, and the reimbursement asset is separate. P&L may net them.

Recognition test

Present obligation from past event AND outflow probable (> 50%) AND reliable estimate

All three must be met. If not, disclose a contingent liability unless the outflow is remote.

Onerous contract provision

Provision = lower of (unavoidable cost of fulfilling − expected benefits) and (penalty for exit)

Cost of fulfilling = incremental costs + allocation of other costs directly related to the contract. Impair dedicated assets first under IAS 36.

Restructuring provision

Provision = direct costs necessarily entailed by the restructuring and not associated with ongoing activities

Needs a detailed formal plan and a valid expectation at the reporting date. Exclude retraining, relocation of continuing staff, marketing and future operating losses.

Decommissioning on initial recognition

Dr Asset (IAS 16 cost); Cr Provision, both at present value of expected future cost

Discount at a pre-tax rate reflecting current market assessments of time value and risks specific to the liability.

Unwinding of discount

Finance cost = opening provision × discount rate

Charge to profit or loss each year and add to the provision.

Future operating losses

No provision

There is no past event. Consider impairment of the related assets instead.

Adjusting event test

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

Applies to events up to the date the financial statements are authorised for issue.

Non-adjusting event test

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

If an estimate cannot be made, state that fact.

Dividends declared after the reporting date

No liability at the reporting date → disclose only

The obligation does not exist until the dividend is declared.

Going concern override

After the reporting date, management intends to liquidate or cease trading, or has no realistic alternative → do not prepare on a going concern basis

A deterioration in operating results and financial position after the reporting date may also indicate that the going concern assumption is no longer appropriate.

Authorisation date disclosure

Disclose the date the financial statements were authorised for issue and who gave that authorisation

Users then know that events after that date are not reflected.

Quick revision

• A provision needs a present obligation from a past event, a probable outflow and a reliable estimate.
• Probable in IAS 37 means more likely than not.
• Obligation can be legal or constructive. A constructive obligation arises from a valid expectation created in others.
• No provision for future operating losses.
• Measure at the best estimate. Use expected value for a large population and the most likely outcome for a single obligation.
• Discount if the effect is material, using a pre-tax rate that reflects the risks specific to the liability, and unwind the discount as a finance cost.
• A contingent liability is disclosed unless the chance of outflow is remote. A contingent asset is disclosed only when an inflow is probable and is recognised only when it is virtually certain.
• An onerous contract provision is the lower of the cost of fulfilling the contract and the cost of exiting it, after impairment of assets dedicated to it.
• A restructuring provision needs a detailed formal plan and a valid expectation in those affected that it will be carried out. Include only direct expenditure from the restructuring.
• Decommissioning: recognise a provision at present value and add the same amount to the asset cost when the obligation arises.
• Adjusting events give further evidence of conditions at the reporting date. Non-adjusting events are disclosed if material.
• Dividends declared after the reporting date are not a liability at that date. If the going concern basis is no longer appropriate after the reporting date, that is an adjusting matter affecting the whole basis of preparation.

Common mistakes

• Providing for future operating losses or planned future spending, such as a planned refurbishment. Fix: Check for an obligating event at the reporting date. If the entity can avoid the cost by its future actions, there is no present obligation, so no provision.
• Treating a board decision as a constructive obligation. Fix: Look for communication that creates a valid expectation in the other party, such as an announcement or established practice. A decision that has not been communicated is not enough.
• Recognising a contingent liability because the amount is large. Fix: Size affects disclosure and materiality only. Recognition depends on a present obligation, probable outflow and reliable estimate.
• Treating a probable inflow as an asset. Fix: Assets need virtually certain. Probable only requires disclosure of the contingent asset.
• Providing for a restructuring because the board approved it before the year end. Fix: Check for a detailed plan and a valid expectation (announcement or implementation started) by the reporting date. Without these, no provision.
• Including retraining, relocation of continuing staff or marketing costs in a restructuring provision. Fix: Include only direct costs necessarily entailed and not associated with ongoing activities. Redundancy and contract termination penalties qualify.
• Recording a dividend declared after the reporting date as a liability. Fix: A liability needs a present obligation at the reporting date. No declaration means no obligation. Disclose only.
• Treating a fall in the market value of investments after the reporting date as adjusting. Fix: Market movements after the reporting date reflect new conditions. They are non-adjusting. Disclose if material.

Exam tips

• Write the three recognition tests as a short list and tick each one against the scenario. Markers award marks for applying the criteria, not for reciting them.
• In a constructive obligation scenario, quote the evidence: an announcement, a published policy or past practice. Say why it creates a valid expectation.
• Show whether discounting is material and state the rate you use. Show the unwinding as a separate line in finance costs.
• If a provision is not recognised, say so and explain the alternative: contingent liability disclosure, unless an outflow is remote.
• Add one sentence of professional judgement or ethics where the scenario hints that management may be understating or overstating a provision to manage profit.
• Always give the threshold words: probable for provisions and disclosing contingent assets, virtually certain for recognising an asset, remote for ignoring a contingent liability.
• Use the facts given. Quote the lawyer's opinion, the percentage, or the wording of a contract, then link it to the test.
• If the scenario involves an acquisition, check immediately for the IFRS 3 exception before writing 'not recognised'.