CAT / FIA FFA Syllabus D. Recording Transactions And Events - Provisions. - Notes 1 / 3
A provision is a liability of uncertain timing or amount.
IAS 37 requires a provision be recognised when all of the following apply:
an entity has a present obligation (legal or constructive) as a result of a past event
it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation
a reliable estimate can be made of the amount of the obligation
Therefore, a provision is made for something which will probably happen. It should be recognised when it is probable that a transfer of economic events will take place and when its amount can be estimated reliably.
Provisions can be distinguished from other liabilities (e.g. trade payables and accruals) due to the uncertainty concerning the timing or amount of the future expenditure required in settlement. In contrast, trade payables are liabilities to pay for goods that have been received and invoiced, hence the timing and amount of the expenditure is agreed with the supplier.
A provision is accounted for as follows: -
Dr Expense (I/S)
Cr Provision (SOFP)
The required provision will be reviewed at each year end and increased or decreased as necessary.
To increase a provision:
Dr Expense (I/S)
Cr Provision (SOFP)
To decrease a provision:
Dr Provision (SOFP)
Cr Expense (I/S)
Measurement of Provision
The amount recognised as a provision should be the best estimate of the expenditure required to settle the present obligation at the end of the reporting period.
Provisions for one-off events (restructuring, environmental clean-up, settlement of a lawsuit) are measured at the most likely amount.
Provisions for large populations of events (warranties, customer refunds) are measured at a probability-weighted expected value.
Worked out example
A company sells goods with a warranty for the cost of repairs required in the first 2 months after purchase.
Past experience suggests:
88% of the goods sold will have no defects
7% will have minor defects
5% will have major defects
If minor defects were detected in all products sold, the cost of repairs will be $24,000; if major defects were detected in all products sold, the cost would be $200,000.
What amount of provision should be made?
(88% x 0) + (7% x 24,000) + (5% x 200,000) = $11,680.
Disclosure note
For each class of provision, an entity should disclose
the net book value at the beginning and the end of the period
additional provisions made in the period, including increases to existing provisions
amounts utilised during the period
unused amounts reversed during the period
An entity should also disclose, for each class of provision
a brief description of the nature of the obligation and the expected timing of any resulting outflows of economic benefits
an indication about the uncertainties about the amount and timing of those outflows
the amount of any expected reimbursement, stating the amount of any asset that has been recognised for that expected reimbursement