Status & recent changes
- Amendments effective from 2022 clarified that the cost of fulfilling a contract (for onerous contract tests) includes both incremental costs and an allocation of other costs that relate directly to the contract.
Objective
Ensures provisions, contingent liabilities and contingent assets are recognised and measured appropriately and enough information is disclosed about them.
Scope
- All provisions, contingent liabilities and contingent assets, except those from executory contracts (unless onerous) and those covered by another standard (e.g. income taxes, leases, employee benefits, insurance contracts, financial instruments).
Key definitions
- Provision
- A liability of uncertain timing or amount.
- Constructive obligation
- An obligation arising from an established pattern of past practice, published policies or a sufficiently specific current statement, creating a valid expectation in others that the entity will meet certain responsibilities.
- Contingent liability
- A possible obligation depending on uncertain future events not wholly within the entity's control, or a present obligation where an outflow is not probable or cannot be measured reliably.
- Contingent asset
- A possible asset from past events whose existence will be confirmed only by uncertain future events not wholly within the entity's control.
- Onerous contract
- A contract where the unavoidable costs of meeting the obligations exceed the economic benefits expected under it.
Recognition & measurement
Recognition
- Recognise a provision only when: there is a present obligation (legal or constructive) from a past event; an outflow of resources is probable (more likely than not); and a reliable estimate can be made.
- No provision for future operating losses.
- Onerous contracts: recognise a provision for the unavoidable costs — the lower of the cost of fulfilling the contract and any penalty for leaving it.
- Restructuring provisions need a detailed formal plan and a valid expectation in those affected (plan started or announced) by the reporting date.
- Contingent liabilities: not recognised; disclose unless the possibility of outflow is remote.
- Contingent assets: not recognised; disclose when an inflow is probable. Recognise the asset only when the inflow is virtually certain (it is then no longer contingent).
Measurement
- Best estimate of the expenditure needed to settle the obligation at the reporting date.
- Large populations: expected value. Single obligations: the most likely outcome, considering other outcomes.
- Discount to present value where the effect is material, using a pre-tax rate; the unwinding is a finance cost.
- Reimbursements (e.g. insurance) are recognised as a separate asset only when virtually certain, and cannot exceed the provision.
- Review provisions at each reporting date and use them only for the expenditure they were set up for.
- Restructuring provisions include only direct costs necessarily caused by the restructuring — not retraining, relocating staff, marketing or new systems.
Key disclosures
- For each class of provision: opening and closing amounts, additions, amounts used, unused amounts reversed, and unwinding of discount.
- Nature of the obligation, expected timing and uncertainties.
- For contingent liabilities (not remote) and probable contingent assets: nature and estimated financial effect where practicable.
Common exam traps
- A board decision alone does not create a restructuring obligation before the year end.
- Future repairs or refurbishment are not provided for — there is no obligation independent of future actions.
- Dismantling costs provided for are also added to the asset's cost under IAS 16.
- Probable → provide; possible → disclose; remote → ignore.
Worked example: Warranty provision (expected value)
Scenario. An entity sells goods with a one-year warranty. If all goods sold had minor defects, repairs would cost $1m; if all had major defects, $4m. It expects 75% of goods to have no defects, 20% minor and 5% major.
- Minor: 20% × 1,000,000 = $200,000.
- Major: 5% × 4,000,000 = $200,000.
- Expected value = 0 + 200,000 + 200,000.
Answer: Provision = $400,000.
Practise MCQs on this standard
Test your understanding of IAS 37 with free chapter-wise MCQs and explanations in these question banks.
CAF-1 Financial Accounting and ReportingICAP CAFACCA FA Financial AccountingACCAACCA FR Financial ReportingACCACAF-6 Corporate ReportingICAP CAFCIMA BA3 Fundamentals of Financial AccountingCIMA Certificate in Business AccountingICAEW AF Accounting FundamentalsICAEW ACA Certificate LevelCA Inter P1 Advanced AccountingICAI CA Intermediate
ICAI CA Intermediate examines Indian Accounting Standards, which are based on but can differ from IFRS. Check your syllabus.