Strategic Business Reporting (International) · Provisions, contingencies and events after the reporting period

IAS 37 Provisions: Recognition and Measurement for ACCA SBR

Updated 11 October 2026 · Fact-checked

A provision is a liability of uncertain timing or amount. IAS 37 requires you to recognise it when there is a present obligation from a past event, an outflow is probable (more likely than not), and a reliable estimate exists. Measure it at the best estimate, discounted if the time value of money is material.

Understand IAS 37 Provisions Recognition and Measurement

A provision is a liability of uncertain timing or amount. It is still a liability, so it meets the Conceptual Framework definition: a present obligation to transfer an economic resource as a result of past events. The word 'provision' only tells you that some uncertainty exists. A trade payable has no real uncertainty, and an accrual has much less. That is the main difference between a provision and other liabilities.

IAS 37 sets three recognition conditions, and all three must be met. First, the entity has a present obligation (legal or constructive) as a result of a past event. Second, an outflow of economic benefits is probable, meaning more likely than not. Third, a reliable estimate can be made of the amount. If any one fails, no provision is recognised. You then consider disclosure as a contingent liability, unless the outflow is remote.

A legal obligation comes from a contract, legislation or other operation of law. A constructive obligation comes from the entity's own actions. Through an established pattern of past practice, published policies or a specific current statement, it has shown others that it will accept certain responsibilities. As a result, it has created a valid expectation that it will discharge them. Management intention alone is never enough. The 'past event' is the obligating event, which leaves the entity no realistic alternative to settling the obligation. Future operating costs are not provisions, because the entity could avoid them by changing its actions.

Measurement uses the best estimate of the expenditure needed to settle the obligation at the reporting date. For a single obligation, the most likely outcome is usually a good guide. For a large population of items, such as warranty claims, use the expected value, which weights each outcome by its probability. Where the effect of the time value of money is material, discount to present value using 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 is shown as a finance cost. Review provisions at each reporting date and adjust them to the current best estimate.

Two further points are often tested. Expected reimbursements, for example from insurance, are recognised as a separate asset only when receipt is virtually certain, and the asset cannot exceed the provision. Gains from expected disposal of assets are not taken into account when measuring a provision.

Key rules to remember

Recognition test: Present obligation (legal or constructive) from a past event AND outflow probable (more likely than not) AND reliable estimate = recognise a provision; All three conditions must be met. If not, consider a contingent liability disclosure unless an outflow is remote.
Expected value (large population): Provision = Σ (probability × cost of each outcome); Use for a large population of similar items such as warranties or returns. Probabilities must sum to 100%.
Single obligation: Provision = most likely outcome, adjusted if other outcomes are mostly higher or mostly lower; Used for one-off items such as a lawsuit. Do not blindly use the expected value.
Present value: PV = future cash outflow ÷ (1 + r)^n; r is a pre-tax discount rate reflecting the time value of money and risks specific to the liability. Discount only if the effect is material.
Unwinding of discount: Finance cost for year = opening provision × discount rate; Debit finance cost, credit provision. The provision grows to the undiscounted amount by the settlement date.
Reimbursement: Separate asset recognised only if receipt is virtually certain; asset ≤ provision; Present gross in the statement of financial position. The statement of profit or loss may show the expense net of the reimbursement.

How to solve IAS 37 Provisions Recognition and Measurement questions

Use this method for any IAS 37 recognition and measurement question. Write each step down, because the marks are for applying it to the scenario.

1Identify the event and the date. Ask whether there was an obligating event on or before the reporting date.
2Test for a present obligation. Decide whether it is legal or constructive. For a constructive obligation, look for a published policy, past practice or a public announcement that creates a valid expectation.
3Test the probability of an outflow. 'Probable' means more likely than not. Say which way the facts point.
4Test for a reliable estimate. In rare cases a reliable estimate cannot be made, so no provision is recognised and the item is disclosed as a contingent liability.
5If all three tests are met, measure at the best estimate. Use the most likely outcome for a single item or the expected value for a large population. Include only costs that are necessary to settle the obligation.
6Discount if the effect is material. Use the pre-tax rate, then calculate the PV and the finance cost for the year.
7Record the double entry. Show the expense, any unwinding in finance costs, and any reimbursement asset. Then state the disclosure needed.
8Conclude. Link your answer to the scenario and, where relevant, to the effect on profit and the ratios of the entity.

Quickest way: Three questions, then the number

When to use it: Use this when time is short, for example when the provision is one part of a longer SBR question.

Ask: did a past event create an obligation at the year end, whether legal or constructive? If not, stop. There is no provision.
Ask: is an outflow more likely than not, and can I estimate it reliably? If not, there is no provision. Consider a contingent liability.
Measure: expected value for many items, most likely amount for one item. Discount only if the question gives a rate or timing.
Unwind: the finance cost equals the opening provision multiplied by the rate. Write one line for the double entry and one line on the reasoning.

Common mistakes in IAS 37 Provisions Recognition and Measurement

Providing for future operating losses or planned future spending, such as a planned refurbishment.
Students see a large expected cost and assume it is a liability.
Fix: Check for an obligating event at the reporting date. If the entity can avoid the cost by its future actions, there is no present obligation, so no provision.
Treating a board decision as a constructive obligation.
Students confuse an internal intention with a commitment made to others.
Fix: Look for communication that creates a valid expectation in the other party, such as an announcement or established practice. A decision that has not been communicated is not enough.
Using the expected value for a single lawsuit or one-off obligation.
Students apply the probability-weighted method to everything.
Fix: For a single obligation, the most likely outcome is usually the best estimate. Expected value is for large populations of similar items.
Discounting at a post-tax rate or the entity's cost of equity, or discounting when the effect is not material.
Students mix up IAS 37 with investment appraisal.
Fix: Use a pre-tax rate that reflects the time value of money and risks specific to the liability. Discount only if the effect is material.
Forgetting the unwinding in later years, or posting it to operating expenses.
Students stop once they have the initial present value.
Fix: Each year, multiply the opening provision by the discount rate and debit finance cost. The provision then grows towards the undiscounted amount.
Netting an insurance recovery off the provision, or recognising it when it is only probable.
The recovery feels certain, so students reduce the liability.
Fix: Recognise a separate asset only when receipt is virtually certain, capped at the provision. Show the provision gross in the statement of financial position.

Worked examples

Example 1

Wavecrest sells electronic devices with a one-year warranty. At 31 December, sales subject to warranty were $10 million. Past experience suggests 80% of devices will have no defects, 15% will have minor defects costing 20% of sales value to repair, and 5% will have major defects costing 60% of sales value to repair. Calculate the warranty provision and explain whether it is recognised.

Show the solution

Obligating event: the sale of the device with a warranty. This creates a legal obligation at the reporting date.
Probability: for the population as a whole, an outflow is probable, because some devices will certainly need repair. Past experience provides a reliable estimate.
Measurement: this is a large population of similar items, so use expected value.
Minor defects: 15% × 20% × $10m = $0.30m.
Major defects: 5% × 60% × $10m = $0.30m.
No defects: 80% × 0 = $0.
Total expected cost = $0.30m + $0.30m = $0.60m.
Discounting: the warranty is for one year, so the effect is likely immaterial. Do not discount unless the question says otherwise.
Entry: Dr Warranty expense $0.6m, Cr Provision $0.6m.

Answer: Recognise a warranty provision of $0.6 million, calculated as an expected value. It is recognised because there is a present legal obligation, an outflow is probable for the population, and a reliable estimate exists.

Example 2

On 1 January 20X1, Delta Mining completed the installation of a plant. The law requires it to clean up the site at the end of 5 years, at an estimated cost of $2,000,000. Assume the pre-tax discount rate is 6% and the clean-up cost is certain. Calculate the provision at initial recognition and the finance cost and carrying amount at 31 December 20X1. (Ignore the asset side of the entry.)

Show the solution

Obligating event: the installation of the plant. A legal obligation exists now, and an outflow is certain. The estimate is reliable.
Timing is 5 years away, so discounting is material.
Discount factor = 1 ÷ (1.06)^5. 1.06^2 = 1.1236; 1.06^3 = 1.191016; 1.06^4 = 1.262477; 1.06^5 = 1.338226.
PV = 2,000,000 ÷ 1.338226 = $1,494,516 (rounded).
Unwinding for 20X1 = 1,494,516 × 6% = $89,671.
Closing provision at 31 December 20X1 = 1,494,516 + 89,671 = $1,584,187.
Check: 2,000,000 ÷ 1.06^4 = 2,000,000 ÷ 1.262477 = $1,584,187. This matches.
Entry for the year: Dr Finance cost $89,671, Cr Provision $89,671.

Answer: Initial provision is $1,494,516. The 20X1 finance cost (unwinding) is $89,671 and the provision at 31 December 20X1 is $1,584,187. The unwinding is charged to finance costs, not operating expenses.

Exam tips

Write the three recognition tests as a short list and tick each one against the scenario. Markers award marks for applying the criteria, not for reciting them.
In a constructive obligation scenario, quote the evidence: an announcement, a published policy or past practice. Say why it creates a valid expectation.
Show whether discounting is material and state the rate you use. Show the unwinding as a separate line in finance costs.
If a provision is not recognised, say so and explain the alternative: contingent liability disclosure, unless an outflow is remote.
Add one sentence of professional judgement or ethics where the scenario hints that management may be understating or overstating a provision to manage profit.

Practice questions from Provisions, contingencies and events after the reporting period

IAS 37 Provisions Recognition and Measurement 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 and Measurement: frequently asked questions

What is the difference between a provision and a liability under IAS 37?

A provision is a liability of uncertain timing or amount. Other liabilities, such as trade payables, are certain in both. Both must meet the definition of a liability, and a provision also needs a probable outflow and a reliable estimate.

What does probable mean in IAS 37?

Probable means more likely than not, so the chance of an outflow is greater than 50%. It does not mean near certain. Where the chance is below that but not remote, the item is a contingent liability that you disclose.

Can I recognise a provision for a restructuring that the board has approved?

Only if a constructive obligation exists. This needs a detailed formal plan and a valid expectation in those affected, for example by starting to implement the plan or announcing its main features. A board decision on its own is not enough.

How do I treat the unwinding of the discount?

Each year, the finance cost equals the opening provision multiplied by the discount rate. You debit finance cost and credit the provision. The provision then rises towards the undiscounted amount by the date of settlement.