Skip to content

Financial Reporting · Provisions and events after the reporting period

IAS 37 Restructuring, Onerous Contract and Warranty Provisions

Updated 11 October 2026 · Fact-checked

IAS 37 applies one test to every provision: a present obligation from a past event, a probable outflow, and a reliable estimate. Restructuring needs a detailed formal plan and a valid expectation in those affected. Onerous contracts are provided at the lower of exit cost and cost of fulfilling. Warranties use an expected value across all claims.

Understand Specific Provisions: Restructuring, Onerous Contracts, Warranties

A provision is a liability of uncertain timing or amount. IAS 37 says you recognise one only when three conditions are met: the entity has a present obligation (legal or constructive) from a past event, an outflow of economic benefits is probable (more likely than not), and a reliable estimate can be made. If any condition fails, you do not book a provision. You may disclose a contingent liability instead.

The hard part is the obligating event. Intending to spend money is not enough. An entity cannot avoid future operating costs, so you never provide for future operating losses. The question is always: does the entity have no realistic alternative to paying?

For restructuring, a constructive obligation arises only when the entity has a detailed formal plan (business concerned, main locations, staff affected, expenditure, timing) and has raised a valid expectation in those affected, by starting to implement the plan 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, relocation of continuing staff, marketing and investment in new systems, because these relate to future operations.

An onerous contract is one where the unavoidable costs of meeting the obligations exceed the economic benefits expected. Unavoidable cost is the lower of the cost of fulfilling the contract and any compensation or penalty for exiting it. Provide for that net amount. Impairment of assets dedicated to the contract is considered first.

Warranties sold with products create an obligation at the point of sale. Because there are many similar items, you measure the obligation as an expected value across the whole class. Decommissioning and environmental obligations arise when the damage or installation happens. Recognise the provision at present value, and under IAS 16 add the same amount to the cost of the asset. Then unwind the discount each year as a finance cost. A legal claim is provided if, taking legal advice into account, it is more likely than not that the entity will have to pay. Otherwise disclose a contingent liability unless the outflow is remote.

Key rules to remember

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.

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

Use this order for any specific provision question. It stops you booking provisions that IAS 37 forbids.

  1. 1Identify the past event and the date it happened. Is it on or before the reporting date?
  2. 2Test for a present obligation, legal or constructive. For restructuring, check for a formal plan and announcement or implementation before year end.
  3. 3Judge the probability of outflow and whether a reliable estimate exists. If outflow is only possible, disclose a contingent liability.
  4. 4Select the right measurement: expected value for many items, most likely outcome for a single obligation, lower of exit and fulfilment cost for onerous contracts.
  5. 5Strip out costs that relate to future operations, and discount if the effect is material, using a pre-tax rate.
  6. 6Post the double entry: expense to profit or loss, or to the asset cost for decommissioning, with the credit to provision.
  7. 7State the closing balance, any unwinding of the discount, and the disclosure or note treatment, with a one-line reason.

Quickest way: Four-question filter

When to use it: Use in Section A and Section B objective questions where time is short and options differ by one rule.

  1. Was there an obligating event before the year end? If no, answer is no provision.
  2. Restructuring: was it announced or started before year end? If only a board decision, no provision.
  3. Is the amount only costs of the future business, such as losses, retraining or relocation? Remove them.
  4. Pick the measure: expected value, best estimate, or lower of exit and fulfilment cost. Check for discounting and the decommissioning asset.

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

  • Providing for restructuring because the board approved a plan before year end.

    Students treat a decision as an obligation.

    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.

    They are listed in the scenario as part of the restructuring.

    Fix: Include only direct costs necessarily entailed by the restructuring and not associated with ongoing activities. Redundancy is in; future-operation costs are out.

  • Providing for future operating losses.

    Expected losses feel like a liability.

    Fix: Never provide for them. Only an onerous contract gives a provision, and only for the unavoidable net cost.

  • Using the full cost of fulfilling an onerous contract when exit is cheaper.

    Students compute one figure and stop.

    Fix: Calculate both the net cost of fulfilling and the penalty to exit. Provide the lower.

  • Debiting decommissioning cost to profit or loss.

    Students book every provision as an expense.

    Fix: The initial present value goes into the cost of the asset under IAS 16. Only the unwinding goes to finance costs.

  • Forgetting to unwind the discount in later years.

    The initial entry feels complete.

    Fix: Each year increase the provision by opening balance × discount rate, charged to finance costs.

Worked examples

Example 1

At 31 December 20X1, Delta Co sold goods with a one-year warranty. Past experience shows that of the goods sold, 80% will have no defects, 15% will have minor defects costing ₹2,000 each to repair, and 5% will have major defects costing ₹10,000 each. Delta sold 10,000 units in the year, all still under warranty. Calculate the warranty provision and state the double entry.

Show the solution
  1. The sale of the goods is the past event, giving a present obligation. There are many similar items, so use expected value.
  2. Expected cost per unit = (80% × ₹0) + (15% × ₹2,000) + (5% × ₹10,000).
  3. = ₹0 + ₹300 + ₹500 = ₹800 per unit.
  4. Total provision = 10,000 × ₹800 = ₹80,00,000.
  5. Double entry: Dr Warranty expense (profit or loss) ₹80,00,000, Cr Warranty provision ₹80,00,000.

Answer: Warranty provision ₹80,00,000, charged to profit or loss. Dr Warranty expense, Cr Provision.

Example 2

On 1 January 20X1, Rho Co brought an oil platform into use. It is required to remove the platform at the end of its 10-year life. The estimated cost of removal is ₹10,00,00,000. The discount rate is 8% and the 10-year discount factor is 0.463. The platform's other cost is ₹40,00,00,000. Show the initial accounting and the amounts for the year ended 31 December 20X1.

Show the solution
  1. The installation creates a present obligation, so recognise a provision at present value.
  2. PV = ₹10,00,00,000 × 0.463 = ₹4,63,00,000.
  3. Dr Platform (asset) ₹4,63,00,000, Cr Decommissioning provision ₹4,63,00,000.
  4. Total cost of the platform = ₹40,00,00,000 + ₹4,63,00,000 = ₹44,63,00,000.
  5. Depreciation over 10 years = ₹44,63,00,000 ÷ 10 = ₹4,46,30,000.
  6. Unwinding = ₹4,63,00,000 × 8% = ₹37,04,000, Dr Finance cost, Cr Provision.
  7. Closing provision = ₹4,63,00,000 + ₹37,04,000 = ₹5,00,04,000.

Answer: Initial provision ₹4,63,00,000, added to the asset cost. For 20X1: depreciation ₹4,46,30,000, finance cost ₹37,04,000, closing provision ₹5,00,04,000.

Exam tips

  • In OT cases, restructuring questions usually hinge on one date: when the plan was announced or started. Read the dates before the numbers.
  • In constructed response, write the recognition test in one line before calculating. Markers award marks for the reasoning as well as the figure.
  • For decommissioning, show the asset entry, the depreciation and the unwinding as three separate lines so partial credit is clear.
  • Remember that OT answers are all or nothing. Check discounting and which costs are included before choosing an option.
  • If a scenario mentions a legal claim, find the lawyer's view. Probable means provide, possible means disclose, remote means nothing.

Practice questions from Provisions and events after the reporting period

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

When can you recognise a restructuring provision under IAS 37?

You need a constructive obligation at the reporting date. That means a detailed formal plan and a valid expectation in those affected, created by announcing the plan or starting to implement it. Only direct costs such as redundancy are included.

What is the difference between an onerous contract and a future operating loss?

An onerous contract is a binding contract where unavoidable costs exceed expected benefits, so a provision is required. Future operating losses arise from running the business and can be avoided, so IAS 37 forbids providing for them.

How do you account for a decommissioning provision under IAS 37 and IAS 16?

Recognise the present value of the expected cost as a provision and add the same amount to the cost of the asset. Depreciate the asset over its life. Each year unwind the discount as a finance cost, increasing the provision.

How do you account for a legal claim provision?

Provide for the best estimate if it is probable the entity will have to pay, based on legal advice. If payment is only possible, disclose a contingent liability. If it is remote, no disclosure is needed.