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IAS 37 Provisions, Contingent Liabilities and Contingent Assets

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 of economic benefits is probable, and a reliable estimate can be made. If the outflow is only possible, disclose a contingent liability. If an inflow is probable, disclose a contingent asset. Virtually certain inflows are assets.

Understand IAS 37 Provisions, Contingent Liabilities and Assets

A provision is a liability of uncertain timing or amount. It is still a liability, so it sits in the statement of financial position and the charge goes to profit or loss. The uncertainty is about when you pay or how much, not whether an obligation exists.

IAS 37 stops companies from booking vague future costs to smooth profit. You can only recognise a provision when all three criteria are met: (1) a present obligation, legal or constructive, as a result of a past event; (2) a probable outflow of economic benefits, meaning more likely than not; (3) a reliable estimate of the amount.

A legal obligation comes from a contract or law. A constructive obligation arises from your actions: you have created a valid expectation in others that you will accept responsibility, through a published policy or a specific announcement. The key test is that you have no realistic alternative to settling.

A contingent liability is either a possible obligation whose existence depends on a future uncertain event, or a present obligation that fails recognition because payment is not probable or the amount cannot be measured reliably. You do not recognise it. You disclose it, unless the chance of outflow is remote, in which case you disclose nothing.

A contingent asset is a possible asset arising from a past event, confirmed only by uncertain future events. Never recognise it. Disclose it if an inflow is probable. If an inflow is virtually certain, it is no longer contingent and you recognise the asset. Note the asymmetry: the test for assets is tougher, which reflects prudence.

Two common provisions are tested. A restructuring provision needs a detailed formal plan and a valid expectation in those affected, such as starting implementation or announcing the main features. An onerous contract is one where unavoidable costs of meeting the contract exceed the economic benefits expected. You provide for the lower of the net cost of fulfilling it (unavoidable costs less expected benefits) and the compensation or penalties for failing to fulfil it. Future operating losses are never provided for.

Key rules to remember

Three recognition criteria: Present obligation (past event) + probable outflow (> 50%) + reliable estimate = provision; All three must be met. If any one fails, consider a contingent liability instead.
Treatment grid for liabilities: Present obligation + probable outflow + reliable estimate → provision; possible obligation, or present obligation with an outflow that is not probable or cannot be reliably measured → contingent liability (disclose unless the chance of outflow is remote); remote → nothing.; Always test for a present obligation first. Provide only if all three criteria are met. Otherwise disclose a contingent liability, unless the chance of outflow is remote.
Treatment grid for assets: Virtually certain → recognise asset; probable → disclose; otherwise → nothing; Contingent assets are never recognised in the financial statements.
Measurement of a provision: Best estimate of expenditure needed to settle the obligation at the reporting date; Single obligation: most likely outcome. Large population: expected value (Σ outcome × probability). Discount if the time value of money is material.
Onerous contract provision: Provision = lower of (net cost of fulfilling the contract, i.e. unavoidable costs less expected economic benefits) and (compensation or penalties for failing to fulfil it); Provide for the unavoidable net cost, not for future operating losses.
Reimbursement: Recognise a separate asset only if receipt is virtually certain; asset ≤ provision; Show the provision gross in the statement of financial position. The statement of profit or loss charge may be shown net of the reimbursement.

How to solve IAS 37 Provisions, Contingent Liabilities and Assets questions

Use this order for any IAS 37 scenario. It works for objective test questions and for written parts of Section C.

1Identify the past event. Ask what has already happened by the reporting date. Events planned for the future do not count.
2Decide whether a present obligation exists at the reporting date, legal or constructive. For restructuring, check for a detailed formal plan and an announcement or started implementation before the year end.
3Assess the likelihood of outflow: probable (provide), possible (disclose) or remote (ignore).
4Check that a reliable estimate can be made. If not, treat it as a contingent liability.
5Measure the amount: best estimate, expected value for large populations, discounted if material. Include only costs that are necessarily entailed by the obligation and not associated with ongoing activities.
6Post the double entry: Dr expense (or asset cost where the standard allows, such as decommissioning), Cr provision. Next year, adjust for changes and unwind any discount as a finance cost.
7For contingent items, state the disclosure: brief description, estimate of financial effect and uncertainties. Then give the reason for your treatment in a sentence.

Quickest way: Three-question filter

When to use it: Section A and Section B objective questions where you have about 1.5 minutes per question.

Q1: Did an event before the year end create an obligation I cannot avoid? If no, no provision.
Q2: Is payment more likely than not, and can I estimate it reliably? Yes to both, with a present obligation, means provision. Otherwise disclose a contingent liability unless the chance of outflow is remote. Remote means nothing.
Q3: For gains: virtually certain means asset, probable means disclose only, anything less means ignore.
Check the keywords: "formal plan announced before year end" supports restructuring; "future operating losses" or "retraining or relocating continuing staff" never qualifies; "loss-making contract" signals onerous.

Common mistakes in IAS 37 Provisions, Contingent Liabilities and Assets

Providing for future operating losses or future repairs of an owned asset.
The cost feels certain, so students assume a liability exists.
Fix: Ask if there is an obligation to a third party now. With no past event and no obligation, there is no provision. Maintenance you can avoid by selling the asset is not a liability.
Recognising a restructuring provision because the board has decided to restructure after the year end, or without an announcement.
Students treat a board decision as the obligating event.
Fix: Require a detailed formal plan and a valid expectation in those affected by the reporting date. Otherwise no provision at that date.
Recognising a probable contingent asset as an asset.
Students mirror the liability rule, where probable means recognise.
Fix: Remember the assets rule is stricter. Only virtually certain inflows are recognised. Probable is disclosure only.
Including costs of retraining, relocating staff or marketing in a restructuring provision.
These costs arise from the same programme, so they look related.
Fix: Include only direct expenditure necessarily entailed by the restructuring and not associated with ongoing activities, such as redundancy costs. Exclude the rest.
Disclosing a contingent liability where the chance of outflow is remote, or ignoring a probable outflow because the amount is only an estimate.
Students mix up possible and remote, or think an estimate cannot be reliable.
Fix: Use the grid. A possible obligation, or a present obligation where the outflow is not probable or cannot be measured reliably, is a contingent liability, disclosed unless the chance of outflow is remote. If it is remote, disclose nothing. Estimates are normal in IAS 37, so do not drop a probable outflow just because the amount is uncertain.
Offsetting an insurance recovery against the provision in the statement of financial position.
Students want to show the net cost.
Fix: Show the provision gross and the reimbursement as a separate asset, only when receipt is virtually certain.

Worked examples

Example 1

At 31 December 20X5 Kestrel Co is defending a customer claim. Its lawyers say it is probable the company will lose and pay $400,000. Separately, Kestrel is suing a supplier for $150,000. Its lawyers say a win is probable but not virtually certain. Explain the accounting treatment of each.

Show the solution

Customer claim: the past event is the alleged fault before the year end, giving a present obligation on the lawyers' view. Outflow is probable and the amount is estimated at $400,000.
All three criteria are met, so Kestrel recognises a provision of $400,000: Dr Legal expense $400,000, Cr Provision $400,000.
Supplier claim: this is a possible asset from a past event, confirmed only by the court outcome. It is a contingent asset.
Inflow is probable but not virtually certain, so no asset is recognised. Kestrel discloses a brief description and the estimated financial effect of $150,000 in the notes.

Answer: Recognise a provision of $400,000 for the customer claim. Disclose, but do not recognise, the $150,000 contingent asset.

Example 2

Delta Co's year end is 30 June 20X6. On 15 June the board approved a detailed formal plan to close a factory and announced it to employees and the press on 20 June. Estimated costs: redundancy $2.4m, retraining of staff who remain $0.5m, relocation of equipment $0.7m, and future operating losses of the factory until closure $0.3m. Calculate the provision.

Show the solution

Test the criteria: a detailed formal plan existed and was announced before the year end, so a constructive obligation exists at 30 June 20X6. Outflow is probable and the costs are estimated.
Redundancy of $2.4m is a direct cost necessarily entailed by the restructuring, so include it.
Retraining of remaining staff of $0.5m relates to continuing staff and ongoing activities, so exclude it.
Relocation of equipment of $0.7m is a cost of continuing operations. No past event creates a present obligation for it at the reporting date, so exclude it.
Future operating losses of $0.3m are never provided for, so exclude them.
Provision = $2.4m.

Answer: Delta recognises a restructuring provision of $2.4m (Dr Profit or loss, Cr Provision).

Exam tips

In objective tests, the trap is nearly always the date: check whether the obligating event or announcement happened before the reporting date.
Learn the two grids (liabilities and assets) as a pair. Examiners often test the asymmetry: probable liability is provided, probable asset is only disclosed.
In Section C, write the three criteria out and apply each to the facts in one line. This shows the marker your reasoning and secures marks even if the number is off.
For restructuring and onerous contracts, list each cost and say "include" or "exclude" with a reason. Do not simply give a total.
Where a question asks for the journal, give both sides and label the account names. Remember to unwind discount as a finance cost in later years.

Practice questions from Reporting financial performance

IAS 37 Provisions, Contingent Liabilities and Assets 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, Contingent Liabilities and Assets: frequently asked questions

What is the difference between a provision and a contingent liability?

A provision is recognised in the statement of financial position because there is a present obligation, a probable outflow and a reliable estimate. A contingent liability fails one of these tests, for example the outflow is only possible. You disclose it in the notes and do not recognise it.

When should you recognise a provision under IAS 37?

Recognise it when you have a present legal or constructive obligation from a past event, payment is probable (more likely than not) and you can estimate the amount reliably. If any one of the three fails, no provision is booked.

How are contingent assets treated in ACCA FR?

You never recognise a contingent asset. If an inflow of benefits is probable, you disclose it in the notes. If the inflow is virtually certain, it is no longer contingent and you recognise it as an asset.

What is an onerous contract under IAS 37?

It is a contract where the unavoidable costs of meeting its obligations exceed the economic benefits you expect to receive. You recognise a provision for the lower of the net cost of fulfilling the contract (unavoidable costs less expected benefits) and the compensation or penalties for failing to fulfil it. You do not provide for general future operating losses.

Can a board decision alone create a restructuring provision?

No. A decision is not enough. By the reporting date you need a detailed formal plan and must have raised a valid expectation in those affected, by starting to implement the plan or announcing its main features.