Provisions, liabilities, obligations and contingencies

Learning objectives

• Identify the elements of the IAS 37 definitions: provision, liability, obligating event, legal and constructive obligation, contingent liability and contingent asset, onerous contract, restructuring.L1
• Distinguish a provision from a trade payable and from an accrual according to the degree of uncertainty about timing or amount.L1, L2
• Distinguish a provision from a contingent liability (a possible obligation, or a present obligation that does not meet the criteria).L1, L2

Normative references

• IAS 37 §10Definitions: provision (a liability of uncertain timing or amount); liability (a present obligation arising from past events, the settlement of which is expected to result in an outflow of resources embodying economic benefits); obligating event (an event that creates a legal or constructive obligation that results in the entity having no realistic alternative to settling it); legal obligation (derived from a contract, legislation or other operation of law); constructive obligation (derived from the entity's actions where, by an established pattern of past practice, published policies or a sufficiently specific current statement, it has indicated that it will accept certain responsibilities and has thereby created a valid expectation on the part of other parties); contingent liability (a possible obligation whose existence will be confirmed only by uncertain future events not wholly within the control of the entity, or a present obligation not recognised because an outflow is not probable or the amount cannot be measured with sufficient reliability); contingent asset (a possible asset whose existence depends on such events); onerous contract (unavoidable costs exceeding the economic benefits expected); restructuring (a programme planned and controlled by management that materially changes the scope of a business or the manner in which it is conducted).
• IAS 37 §11Provisions can be distinguished from other liabilities, such as trade payables and accruals, by the uncertainty about the timing or amount of the future expenditure. Trade payables relate to goods or services received and invoiced or formally agreed; accruals to goods or services received but not paid, invoiced or formally agreed. Accruals sometimes require estimation, but the uncertainty is generally much less.
• IAS 37In a general sense, all provisions are contingent because they are uncertain; the standard, however, uses 'contingent' for liabilities and assets that are not recognised because their existence will be confirmed only by uncertain future events not wholly within the entity's control, and 'contingent liability' for liabilities that do not meet the recognition criteria.
• IAS 37 §13The standard distinguishes provisions, which are recognised as liabilities (present obligations with a probable outflow, provided a reliable estimate can be made), from contingent liabilities, which are not recognised because they are either possible obligations or present obligations that do not meet the recognition criteria.

Original summaries of the paragraphs (reference register), never a quotation of the standard.

14 questions

• Under IAS 37, a provision is a liability of uncertain timing or amount.L1
• Which statement best describes an obligating event under IAS 37?L1
• A constructive obligation can arise only from a signed contract or a piece of legislation.L1
• Which of these sources give rise to a legal obligation under IAS 37?L1
• In December, Pellicor received and accepted an invoice of 18,400 for parts delivered, payable in February. How should this amount be classified at the reporting date?L1
• An accrual may require an estimate, but the uncertainty surrounding it is generally much less than for a provision.L1
• A consulting firm completed an engagement for Quintane in December at the agreed hourly rate; the hours are known, but the invoice of 7,350 will arrive only in January. How does Quintane present this amount at the reporting date?L2
• A contingent liability is recognised as a liability as soon as its amount is material.L2
• Which of these situations correspond to a contingent liability?L2
• All provisions involve some uncertainty. Why, then, does IAS 37 not describe them as "contingent"?L2
• At its reporting date, Rosvald has three items: (1) legal fees for a hearing held in December, at the agreed rate, not yet invoiced; (2) a customer claim for which Rosvald denies any liability, its advisers considering an unfavourable ruling possible but unlikely; (3) the repairs expected on products sold under warranty, estimated from past experience. Justify the classification of each item: accrual, provision or contingent liability.L2
• On 20 December, Talvène's board decides, in a meeting, to refund dissatisfied customers in future beyond its contractual obligations. Nothing has been announced externally and this was not a practice of the company. Is there a constructive obligation at the reporting date of 31 December?L1
• Explain in your own words what IAS 37 means by "onerous contract" and by "restructuring", then state what these two notions have in common with the definition of a provision.L1
• Which definition corresponds to a restructuring under IAS 37?L2