Financial Accounting · Provisions and contingencies

IAS 37 Provisions: Recognition Criteria Explained

Updated 11 October 2026 · Fact-checked

Under IAS 37, you recognise a provision only when three conditions are all met: the entity has a present obligation (legal or constructive) from a past event, an outflow of economic benefits is probable, and the amount can be estimated reliably. If any one fails, you do not recognise a provision.

Understand IAS 37 Provisions: Recognition Criteria

A provision is a liability of uncertain timing or amount. It is still a liability. The uncertainty is only about when you pay or how much. A trade payable with an invoice is not a provision because both are known.

IAS 37 stops companies from booking provisions just because they expect future costs. You must meet three tests, and all three must pass.

Present obligation as a result of a past event. The entity has no realistic alternative to settling. This is called the obligating event.
Probable outflow of economic benefits. Probable means more likely than not, so above 50%.
Reliable estimate of the amount.

An obligation can be legal, arising from a contract, law or other legal means. It can also be constructive. A constructive obligation arises when the entity's past practice, published policies or a specific current statement have created a valid expectation in others that it will accept responsibility, and so it has no real alternative to acting. A board decision alone is not enough. The decision must be communicated to those affected.

The obligation must exist at the reporting date. Future operating costs are not obligations because you can avoid them by changing how you operate. For example, you cannot provide for future repairs you could avoid by selling the asset or stopping the activity.

If an outflow is only possible, not probable, you do not book a provision. You disclose a contingent liability instead, unless the chance of outflow is remote. If the estimate cannot be made reliably, the item is also treated as a contingent liability. IAS 37 says a reliable estimate is almost always possible when a provision is otherwise justified.

Key formulas to remember

Recognition test: Provision = present obligation (past event) AND probable outflow AND reliable estimate; All three conditions must be met. Failing any one means no provision.
Meaning of probable: Probable = more likely than not (above 50%); Possible but not probable gives a contingent liability disclosure, not a provision.
Journal to recognise: Dr Expense (profit or loss) / Cr Provision (liability); If the provision is part of an asset's cost, such as decommissioning, the debit goes to the asset instead.
Obligation types: Obligation = legal OR constructive; Constructive needs past practice or a clear statement that creates a valid expectation.
Future operating losses: No provision for future operating losses; There is no past event. Onerous contracts are the exception and are covered separately.

How to solve IAS 37 Provisions: Recognition Criteria questions

Use the same sequence for any IAS 37 recognition question. Work through the tests in order and stop when one fails.

1Identify the event in the question and its date. Ask whether it happened on or before the reporting date.
2Test for a present obligation. Is there a legal duty, or has the entity created a valid expectation by practice or a communicated announcement?
3Ask whether the entity could avoid the cost by its future actions. If it could, there is no obligation.
4Test the likelihood of outflow. Above 50% is probable. Lower but not remote is possible. Very low is remote.
5Test for a reliable estimate. Most questions give a figure, so this usually passes.
6Decide the treatment. All three met: recognise a provision. Outflow only possible: disclose a contingent liability. Remote: do nothing.
7If recognising, post Dr expense, Cr provision, and state the amount.

Quickest way: Three-gate check

When to use it: Use it for multiple choice and multiple response questions where you have about 60 to 90 seconds.

Look for the past event before the year end. Wording such as 'plans to' or 'will' with no announcement is a warning sign.
Look for the probability words: 'probable', 'likely', 'possible', 'remote'. Only probable passes.
Check the amount is given or estimable.
If all three pass, pick the option that recognises a provision. Otherwise pick contingent liability or no entry.
For number entry, state the amount of the provision only, not any amount that is merely possible.

Common mistakes in IAS 37 Provisions: Recognition Criteria

Providing for future operating costs or future losses.
The cost feels certain, so students assume it is a liability.
Fix: Ask whether a past event has created an obligation now. If the cost can be avoided by future action, there is no provision.
Treating 'possible' as 'probable'.
Students read any chance of payment as enough.
Fix: Probable means more likely than not. Possible gives a contingent liability note only.
Recognising a restructuring provision because the board has decided.
A decision seems like a commitment.
Fix: There must also be a detailed formal plan and a valid expectation created, for example by announcing it to those affected, before the reporting date.
Ignoring constructive obligations.
Students look only for a contract or law.
Fix: Check for past practice or public promises, such as a policy of refunding customers or cleaning up contamination, that create a valid expectation.
Confusing a provision with an accrual or payable.
Both are liabilities, so they look alike.
Fix: A provision has uncertain timing or amount. An accrual or payable is for goods or services received where the amount is reasonably certain.
Debiting the wrong account when recognising.
Students remember only 'Cr provision'.
Fix: Debit the expense in profit or loss, unless the cost forms part of an asset, in which case debit the asset.

Worked examples

Example 1

At 31 December, a company is being sued by a customer. Its lawyers advise that it is probable the company will lose and pay damages. The best estimate of damages is $80,000. Should a provision be recognised, and for how much?

Show the solution

Past event: the event giving rise to the claim occurred before the year end, so there is a present obligation.
Probable outflow: lawyers say it is probable, so the test is met.
Reliable estimate: the best estimate is $80,000.
All three conditions are met, so recognise a provision.
Journal: Dr Legal expense (profit or loss) $80,000, Cr Provision $80,000.

Answer: Recognise a provision of $80,000.

Example 2

On 15 December a company's board decided to close a factory in March next year. No detailed plan has been approved and nobody has been told. Estimated closure costs are $300,000. The year end is 31 December. What is the treatment?

Show the solution

Past event: a board decision alone is not an obligating event.
Constructive obligation: there is no detailed formal plan and no announcement, so no valid expectation has been created in those affected.
Because there is no present obligation at the year end, the first condition fails.
The probability and estimate tests do not need to be considered, as all three must be met.

Answer: Do not recognise a provision. The $300,000 is not recorded at 31 December, because there is no present obligation.

Exam tips

Write 'all three conditions' in your head every time. Many wrong options pass two out of three.
Watch the date. Events after the reporting date do not create an obligation at the reporting date, although they may give evidence about one.
In multiple response questions, select only the stated number of options and check each against the three tests.
In number entry, give only the amount to recognise. Exclude amounts that are only possible or that relate to future operations.
Know the three outcomes cold: provision, contingent liability disclosure, or nothing.

Practice questions from Provisions and contingencies

IAS 37 Provisions: Recognition Criteria in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

IAS 37 Provisions: Recognition Criteria: frequently asked questions

What are the IAS 37 recognition criteria for a provision?

There must be a present obligation, legal or constructive, arising from a past event. An outflow of economic benefits must be probable. The amount must be estimated reliably. All three must be met.

What is the difference between a provision and a liability?

A provision is a type of liability where the timing or amount is uncertain. Other liabilities, such as trade payables, have a clear amount and timing. Both meet the definition of a liability.

What is a constructive obligation?

It arises from the entity's own actions, such as established past practice or a clear public statement. These actions create a valid expectation in others that the entity will accept responsibility. The entity then has no realistic alternative but to settle.

What happens if an outflow is only possible?

You do not recognise a provision. You disclose a contingent liability in the notes, unless the chance of outflow is remote, in which case no disclosure is needed.