What is a provision?
A provision recognises a cost the business is likely to pay but where the exact amount or date isn't yet known. It's recorded now so the expense falls in the right period.
Recognition criteria (IAS 37)
Under IAS 37, recognise a provision when:
- There is a present obligation (legal or constructive) from a past event,
- An outflow of resources is probable (more likely than not), and
- The amount can be reliably estimated.
If these aren't met, it may be a contingent liability disclosed in the notes.
Common examples
- Product warranties
- Legal claims
- Restructuring costs
- Onerous contracts
- Restoration or decommissioning costs
- Refunds and returns
Accounting entry
Debit the relevant expense, credit provision (liability). When the cost is paid, the provision is used up. Provisions are reviewed at each reporting date and adjusted.
Example
A retailer sells $500,000 of electronics with a one-year warranty. History shows repair costs of about 2% of sales, so it records a $10,000 warranty provision.
Provision vs allowance
In everyday language, "provision" is also used for asset reductions such as the [allowance for doubtful accounts](/glossary/allowance-for-doubtful-accounts). Under IAS 37 a provision specifically means a liability.