Financial Accounting · Provisions and contingencies

Measuring Provisions and Accounting Entries under IAS 37

Updated 11 October 2026 · Fact-checked

A provision is measured at the best estimate of the cost of settling the obligation at the reporting date. Use expected value for many similar items and the most likely outcome for a single obligation. Create it with Dr expense, Cr provision. Later, only the change goes through profit or loss.

Understand Measuring Provisions and Accounting Entries

Once you know a provision must be recognised, the next job is to put a number on it. IAS 37 says to use the best estimate of the expenditure needed to settle the present obligation at the end of the reporting period. It is the amount the entity would rationally pay to settle the obligation or transfer it to a third party.

How you find the best estimate depends on the situation. If you have a large population of similar items, such as thousands of products under warranty, use expected value. You weight each possible outcome by its probability and add them up. If you have a single obligation, such as one lawsuit, the most likely outcome is usually the best estimate. IAS 37 adds that if other outcomes are mostly higher or mostly lower, the best estimate may be a higher or lower amount.

If the money will be paid far in the future and the time value of money is material, the provision is discounted to present value. The discount rate is a pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the liability. Each year the discount unwinds, and the unwinding is a finance cost in profit or loss. Future events, such as new laws, are included only if there is sufficient objective evidence they will happen. Gains from expected disposal of assets are not used to reduce the provision.

The accounting is simple. When you first create a provision, debit the relevant expense in profit or loss and credit the provision (a liability) in the statement of financial position. At each later year end, you review the estimate. If it has risen, debit expense and credit provision with the increase only. If it has fallen, debit provision and credit the expense with the decrease only. If the obligation ends and no payment is needed, release the balance the same way. Use the provision only for the expenditure it was set up for.

If an outflow is virtually certain to be reimbursed, for example by an insurer, the reimbursement is recognised as a separate asset. It is not netted off the provision in the statement of financial position. The expense in profit or loss may be shown net of the reimbursement.

Key formulas to remember

Expected value: Expected value = Σ (outcome × probability); Use for a large population of similar items, such as warranty claims. Probabilities must add up to 100%.
Most likely outcome: Best estimate = single most likely amount; Use for a single obligation. Adjust upwards or downwards if other possible outcomes are mostly higher or lower.
Creating a provision: Dr Expense (profit or loss); Cr Provision (liability); Post the full amount in the first year.
Adjusting a provision: Charge or credit to profit or loss = closing provision − opening provision; A positive result is an extra expense. A negative result is a credit, which reduces expenses.
Discounted provision: Present value = future payment ÷ (1 + r)ⁿ; Use when the time value of money is material. Unwinding in later years = opening provision × r, charged as a finance cost.

How to solve Measuring Provisions and Accounting Entries questions

Follow this order for any question on measuring and recording a provision.

1Check that a provision is needed: a present obligation from a past event, a probable outflow, and a reliable estimate. If not, the answer may be a disclosure only.
2Decide the measurement basis. Many similar items means expected value. A single obligation means the most likely outcome.
3Calculate the best estimate. For expected value, multiply each outcome by its probability and add them.
4Check whether discounting applies. If payment is years away and the question gives a rate, discount. Otherwise ignore it.
5Find the opening provision from the previous year's statement of financial position, if any.
6Work out the change: closing provision minus opening provision.
7Post the journal. An increase is Dr expense, Cr provision. A decrease is Dr provision, Cr expense.
8Show the closing provision as a liability and the charge or credit in profit or loss.

Quickest way: Closing minus opening shortcut

When to use it: Use for multiple choice and number entry questions that ask for the profit or loss charge or the closing balance of a provision.

Write down the new best estimate. This is the closing provision.
Subtract the opening provision. The result is the profit or loss entry.
If the result is positive, it is an expense. If negative, it is a credit to expenses.
For warranties, expected value is units × probability × cost per claim. Add the groups together.
Read the question for any amount actually paid out and charged against the provision, as this changes the opening balance used for the movement.

Common mistakes in Measuring Provisions and Accounting Entries

Charging the full new provision to profit or loss every year.
Students forget that last year's provision is already in the liability.
Fix: Charge only the movement: closing provision minus opening provision.
Using the most likely outcome for a large population of similar items.
It feels simpler than weighting probabilities.
Fix: Many similar items means expected value. Reserve the most likely outcome for a single obligation.
Crediting the provision but debiting nothing in profit or loss, or debiting the statement of financial position.
Students mix up the double entry and think of a provision as an asset adjustment.
Fix: A provision is a liability, so credit it. The debit is an expense in profit or loss.
Adding up outcomes without multiplying by probability.
Students rush and treat the possible outcomes as a list of costs.
Fix: Multiply each outcome by its probability first. Then check that the probabilities total 100%.
Releasing a provision by crediting the statement of financial position or reserves.
Students treat a reduction as a correction of equity.
Fix: A reduction in estimate is a credit to profit or loss. Debit provision, credit the expense.
Ignoring the unwinding of the discount.
Students stop after the first year's present value calculation.
Fix: Each year increase the provision by the discount rate and charge that increase to finance costs.

Worked examples

Example 1

At 31 December Year 1, a company sold 10,000 units under a one-year warranty. Past experience suggests 80% will need no repair, 15% will need minor repairs costing $20 each, and 5% will need major repairs costing $100 each. There was no warranty provision at the start of the year. Calculate the provision and the charge to profit or loss.

Show the solution

Use expected value because there are many similar items.
No repair: 80% × 10,000 × $0 = $0.
Minor repairs: 15% × 10,000 = 1,500 units × $20 = $30,000.
Major repairs: 5% × 10,000 = 500 units × $100 = $50,000.
Closing provision = $0 + $30,000 + $50,000 = $80,000.
Opening provision is nil, so the charge is $80,000 − $0 = $80,000.
Journal: Dr Warranty expense $80,000; Cr Warranty provision $80,000.

Answer: The provision is $80,000, and profit or loss is charged $80,000.

Example 2

At 31 December Year 1 a company had a provision of $80,000 for legal claims. At 31 December Year 2 the best estimate of the liability is $65,000. Show the journal and state the effect on profit or loss for Year 2. Then suppose instead that the Year 2 estimate was $95,000, and show that journal.

Show the solution

Opening provision is $80,000.
Case 1: closing provision is $65,000.
Movement = $65,000 − $80,000 = $15,000 decrease.
Journal: Dr Provision for legal claims $15,000; Cr Legal expense (profit or loss) $15,000.
Profit for Year 2 is increased by $15,000 because expenses are reduced.
Case 2: closing provision is $95,000.
Movement = $95,000 − $80,000 = $15,000 increase.
Journal: Dr Legal expense $15,000; Cr Provision for legal claims $15,000.

Answer: Case 1: Dr Provision $15,000, Cr Legal expense $15,000, increasing profit by $15,000. Case 2: Dr Legal expense $15,000, Cr Provision $15,000, reducing profit by $15,000.

Exam tips

Look for the words 'large number of similar items' or 'single case'. They tell you whether to use expected value or the most likely outcome.
In number entry questions, check whether the answer needed is the closing provision or the profit or loss charge. They are often different.
Always check for an opening balance. If one exists, you only post the movement.
In multiple response questions, remember that a provision is a liability and the matching debit is an expense, not an asset.
Ignore discounting unless the question mentions a discount rate or says the payment is due in future years.

Practice questions from Provisions and contingencies

Measuring Provisions and Accounting Entries: frequently asked questions

What is the best estimate of a provision under IAS 37?

It is the amount an entity would rationally pay to settle the obligation at the end of the reporting period, or to transfer it to a third party. Use expected value for large populations and the most likely outcome for a single obligation.

What is the journal entry for creating a provision?

Debit the relevant expense in profit or loss and credit the provision in liabilities. For a warranty provision, debit warranty expense and credit warranty provision.

How do I adjust a provision in the statement of profit or loss?

Compare the new provision with the opening balance. If it is higher, charge the increase as an expense. If it is lower, credit the decrease to profit or loss. Never charge the whole closing balance again.

When do I discount a provision?

Discount when the effect of the time value of money is material and payment is due well into the future. The unwinding of the discount in later years is a finance cost, not an operating expense.