The three recognition conditions

Learning objectives

• Identify the three cumulative conditions for recognising a provision.L1
• Determine whether an outflow of resources is probable (more likely than not), including for a class of similar obligations considered as a whole.L1, L2, L3
• Recognise a provision when the three criteria are met.L1, L2
• Assess the extremely rare case in which no reliable estimate can be made and draw the consequence (contingent liability disclosed).L2, L3

Normative references

• IAS 37 §14A provision is recognised when, and only when, three conditions are met: a present obligation (legal or constructive) as a result of a past event; a probable outflow of resources embodying economic benefits to settle it; a reliable estimate of the amount. Otherwise, no provision is recognised.
• IAS 37 §23An outflow of resources is regarded as probable if it is more likely than not to occur. Otherwise, the entity discloses a contingent liability, unless the possibility of an outflow is remote.
• IAS 37 §24Where there are a number of similar obligations (product warranties, for example), the probability of an outflow is determined by considering the class of obligations as a whole: even if it is small for any one item, an outflow may well be probable for the class as a whole.
• IAS 37 §25The use of estimates is an essential part of the preparation of financial statements, especially for provisions; except in extremely rare cases, the entity can determine a range of possible outcomes and therefore make an estimate that is sufficiently reliable to recognise a provision.
• IAS 37In the extremely rare case where no reliable estimate can be made, a liability exists that cannot be recognised; it is disclosed as a contingent liability.

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

16 questions

• A provision is recognised as soon as two of the three IAS 37 recognition conditions are met.L1
• Which conditions must be met to recognise a provision?L1
• Under IAS 37, when is an outflow of resources "probable"?L1
• When an outflow of resources is not probable, the entity discloses a contingent liability, unless the possibility of an outflow is remote.L1
• A customer of Ulmara was injured in November 20X5 by a defective appliance sold by Ulmara. At the reporting date of 31 December 20X5, Ulmara's advisers consider its liability established and compensation probable; the best estimate of the amount payable is {best_estimate}. Record the entry at the reporting date.L1
• In October 20X5, Vérandis's plant discharged effluent into a river above the limits allowed by law. The authority has opened proceedings; at the reporting date of 31 December 20X5, a fine is probable and its best estimate, based on the statutory scale, is {fine_estimate}. Record the year-end entry.L2
• Wexhal sells thousands of radiators each year with a two-year warranty; for each radiator taken individually, the probability of a repair is low. How should it assess whether an outflow of resources is probable?L2
• Xandrel sold 4,000 scooters in 20X5 with a one-year contractual warranty. Based on its history, each scooter has a 3% chance of needing a repair. What does Xandrel conclude at 31 December 20X5?L2
• When the amount of a present obligation is uncertain, the entity refrains from recognising a provision and only discloses it in the notes.L2
• In an extremely rare case, a present obligation exists and the outflow is probable, but no reliable estimate of its amount is possible. What is the treatment?L2
• Zorvane is being sued by a distributor it removed. Its lawyers consider an adverse ruling probable, with damages of between 300,000 and 500,000 depending on the court's assessment of the loss. The finance director proposes to recognise nothing "for lack of a reliable amount". What should be concluded?L3
• Corvessa owes probable compensation of 64,000 to a customer for a delivery delay that occurred in 20X5; the three recognition conditions are met. The accountant recorded: debit retained earnings (equity) 64,000, credit provision 64,000. Where is the error?L2
• Dalmeri sold 25,000 coffee makers with a one-year warranty. Its controller concludes: "Each coffee maker has only a 2% risk of failure; no outflow is probable, so no provision." What is the error in reasoning?L2
• For five separate present obligations of Elvarin, all of which can be reliably estimated, the probability of an outflow of resources is estimated as follows. Which give rise to a provision?L3
• Irdane is both the defendant in a dispute with a customer (adverse ruling probable, amount estimable) and the claimant in a dispute against a subcontractor (gain probable, amount estimable). Neither outcome is virtually certain. What is the overall treatment?L3
• Querane sold {units_sold} drills with a one-year warranty. It expects {claim_rate}% of them to be repaired, at an average cost of {repair_cost} per repair. No provision existed before. Record the entry setting up the provision at the reporting date.L2