Financial Accounting · Provisions and contingencies

Warranty, Restructuring and Onerous Contract Provisions Under IAS 37

Updated 11 October 2026 · Fact-checked

IAS 37 says you recognise a provision only when there is a present obligation from a past event, an outflow is probable, and you can estimate it reliably. Apply this to warranties (expected cost across all sales), restructuring (needs a detailed plan and valid expectation) and onerous contracts (lower of exit cost and cost of fulfilling).

Understand Specific Provisions: Warranties, Restructuring and Onerous Contracts

A provision is a liability of uncertain timing or amount. IAS 37 gives three tests. You need a present obligation (legal or constructive) from a past event. An outflow of economic benefits must be probable, meaning more likely than not. And you must be able to make a reliable estimate. If all three are met, you recognise the provision. If any fails, you do not.

If an outflow is only possible, or the amount cannot be measured reliably, you have a contingent liability. You do not recognise it. You disclose it, unless the chance of outflow is remote. A contingent asset is never recognised. You disclose it only if an inflow is probable. If an inflow is virtually certain, it is no longer contingent and is an asset.

Warranties: the past event is the sale of the product with the warranty. You look at the whole population of products sold and use expected values. Even if each item has a low chance of a claim, the class as a whole may make an outflow probable.

Restructuring: a constructive obligation arises only when you have a detailed formal plan and have raised a valid expectation in those affected, by starting to implement it or announcing its main features. A board decision alone is not enough. Include only direct costs of the restructuring, such as redundancy payments. Exclude retraining, relocating staff, marketing and future operating losses.

Onerous contracts: a contract where unavoidable costs of meeting it exceed the benefits expected. Provide for the lower of two figures: the net cost of fulfilling it (the unavoidable costs less the benefits you expect, such as sublet income) and the penalty or compensation for exiting it. Legal claims: provide if, taking advice from lawyers, it is probable you will lose. If a loss is only possible, disclose a contingent liability.

Key formulas to remember

Provision recognition tests: Present obligation from past event AND outflow probable AND reliable estimate; All three must be met. Otherwise disclose a contingent liability or do nothing.
Warranty provision (expected value): Provision = Units sold × Σ (probability of each outcome × cost per unit); Use expected value for a large population of similar items.
Onerous contract provision: Provision = lower of (unavoidable cost of fulfilling the contract − expected benefits, such as sublet income) and (penalty or compensation for exit); The fulfilment figure is a net cost. Compare it with the cost of getting out and provide the lower.
Restructuring provision: Direct restructuring costs only, once plan is detailed and expectation is raised by year end; Exclude retraining, relocation, marketing and future operating losses.
Double entry for a new provision: Dr Expense (profit or loss) / Cr Provision (liability); For a change in an existing provision, post only the increase or decrease to profit or loss.
Contingent items: Contingent liability: disclose unless remote. Contingent asset: disclose only if inflow probable.; Neither is recognised in the statement of financial position.

How to solve Specific Provisions: Warranties, Restructuring and Onerous Contracts questions

Use this method for any IAS 37 question on warranties, restructuring, onerous contracts or legal claims.

1Identify the past event. For a warranty it is the sale. For restructuring it is the plan being announced or started. For a claim it is the incident.
2Check whether there is a present obligation at the reporting date, legal or constructive. Events after the year end do not create one, though they may give evidence.
3Judge the likelihood: probable (more likely than not) means provide. Possible means disclose. Remote means ignore.
4Check that you can estimate the amount reliably. If not, disclose a contingent liability.
5Measure: use expected value for many items, or the most likely outcome for a single item. For onerous contracts take the lower of fulfil and exit cost. For restructuring include direct costs only.
6Post the entry: Dr profit or loss, Cr provision. If a provision already exists, post only the movement.
7State the disclosure if needed, and match the answer to the question: a number, a statement choice or a classification.

Quickest way: Three-gate scan

When to use it: Use in Section A objective questions where you have about 70 seconds per two-mark item.

Gate 1: is there an obligation at the year end? No plan announced, no sale made or no contract signed means no provision.
Gate 2: is the outflow probable? Over 50% likely means provide. Otherwise disclose.
Gate 3: is the amount reliable? If yes, calculate. For restructuring, strip out retraining, relocation and future losses.
For warranties, multiply units by the expected cost per unit. For onerous contracts, pick the lower of the two costs.

Common mistakes in Specific Provisions: Warranties, Restructuring and Onerous Contracts

Providing for a restructuring because the board has decided on it before the year end.
Students treat a decision as an obligation.
Fix: Look for a detailed formal plan and a valid expectation raised in those affected, such as an announcement or the start of implementation. Without that, no provision.
Including retraining, relocation or future operating losses in a restructuring provision.
These feel like restructuring costs.
Fix: Include only direct costs that arise from the restructuring and are not related to ongoing activities, such as redundancy payments. Everything else is expensed as incurred.
Using the cost of exit instead of the lower of exit and fulfilment for an onerous contract.
Students stop after calculating the first figure.
Fix: Always calculate both: the net cost of fulfilling the contract (unavoidable costs less expected benefits such as sublet income) and the exit penalty. Provide the lower.
Recognising a warranty provision only when a claim is received.
Students think in terms of individual items rather than the population sold.
Fix: The sale is the past event. Estimate expected claims on all units sold with cover still running at the year end.
Posting the whole provision to profit or loss every year.
Forgetting the opening balance.
Fix: Compare the required closing provision with the opening one and post only the increase or release the decrease.
Recognising a probable gain from a legal claim as an asset.
Students apply the same probable test to assets and liabilities.
Fix: A contingent asset is not recognised. If an inflow is probable, disclose it. Recognise it as an asset only when the inflow is virtually certain.

Worked examples

Example 1

A company sells 20,000 units in the year, each with a one-year warranty. Past experience shows 80% will have no defects, 15% will have minor defects costing $10 each to repair and 5% will have major defects costing $50 each. Calculate the warranty provision at the year end, and state the entry. Assume all warranties are still running.

Show the solution

The sale with a warranty is the past event, so there is a present obligation.
Expected cost per unit = (80% × $0) + (15% × $10) + (5% × $50) = $0 + $1.50 + $2.50 = $4.00.
Provision = 20,000 × $4.00 = $80,000.
Entry: Dr Warranty expense (profit or loss) $80,000, Cr Warranty provision $80,000 (assuming no opening provision).

Answer: Warranty provision $80,000. Dr Warranty expense, Cr Provision.

Example 2

A company has a non-cancellable warehouse lease with two years remaining at $60,000 a year. It has closed the operation and will not use the warehouse again, but it can sublet the warehouse for $25,000 a year. Ignore discounting. Calculate the provision at the year end.

Show the solution

The contract is onerous: unavoidable cost of meeting it exceeds the benefits.
Cost of fulfilling over 2 remaining years = 2 × $60,000 = $120,000.
Sublet income over 2 years = 2 × $25,000 = $50,000.
Net cost = $120,000 − $50,000 = $70,000. There is no exit penalty, as the lease cannot be cancelled, so $70,000 is the amount.
Entry: Dr Profit or loss $70,000, Cr Onerous contract provision $70,000.

Answer: Provision $70,000, with Dr Profit or loss and Cr Provision.

Exam tips

Read the dates carefully. Many questions turn on whether the plan was announced or the event happened before or after the year end.
In multiple response questions on restructuring, select only direct costs such as redundancy. Reject retraining and relocation.
For legal claims, key words are probable (provide), possible (disclose) and remote (nothing). Watch for the lawyer's advice in the question.
In number entry questions, do the working in order and double check whether an opening provision exists, since only the movement hits profit or loss.
Do not provide for future operating losses. IAS 37 does not allow it, except through the onerous contract rule.

Practice questions from Provisions and contingencies

Specific Provisions: Warranties, Restructuring and Onerous Contracts in other exams

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

Specific Provisions: Warranties, Restructuring and Onerous Contracts: frequently asked questions

What are the conditions for a restructuring provision under IAS 37?

You need a detailed formal plan and a valid expectation in those affected, created by starting to implement the plan or announcing its main features. This must happen by the reporting date. Then include only direct costs of the restructuring.

What is an onerous contract?

It is a contract where the unavoidable costs of meeting it exceed the economic benefits you expect to receive. You recognise a provision for the lower of the net cost of fulfilling it (costs less expected benefits, such as sublet income) and any penalty or compensation for exiting it.

How do I calculate a warranty provision?

Estimate the possible outcomes for the units sold, weight each cost by its probability and multiply by the number of units still under warranty. Post the expense to profit or loss and the credit to a provision.

When is a legal claim a provision rather than a contingent liability?

It is a provision if it is probable you will lose and you can estimate the amount. If a loss is only possible, or cannot be measured reliably, it is a contingent liability and you disclose it. If it is remote, you disclose nothing.