How provisions and contingent liabilities are recognized and measured under IAS 37 and ASC 450

Provisions and contingencies ensure that potential obligations are recognized when probable and measurable, while uncertain or remote exposures remain disclosed but not recorded. IAS 37 (Provisions, Contingent Liabilities, and Contingent Assets) and US GAAP (ASC 450 – Contingencies) both address uncertainty in obligations but differ in terminology, recognition thresholds, and measurement bases. The objective in both frameworks is to ensure that financial statements capture expected outflows that arise from present obligations while avoiding premature recognition of uncertain events.

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How provisions differ from contingent liabilities.

Provisions are liabilities of uncertain timing or amount that are recognized when:

1. There is a present obligation (legal or constructive) as a result of a past event.

2. It is probable (IFRS: more likely than not; GAAP: likely) that an outflow of resources will be required.

3. The amount can be reliably estimated.

Contingent liabilities, on the other hand, are possible obligations depending on uncertain future events, or present obligations that do not meet recognition criteria. They are disclosed unless the possibility of outflow is remote.

Example:

• Provision → warranty obligation, restructuring cost.

• Contingent liability → pending lawsuit outcome uncertain.

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Recognition and measurement under IFRS (IAS 37).

1) Recognition criteria.Recognize a provision when all three conditions above are met.If outflow is possible but not probable → disclose only.If remote → no recognition or disclosure.

2) Measurement.Measure the provision at the best estimate of the expenditure required to settle the obligation at the reporting date.

• Use expected value (probability-weighted average) for large populations.

• Use most likely outcome for single obligations.

• Discount future cash flows if the effect of time value is material.

• Present value = expected cash outflow × (1 / (1 + discount rate)^n).

3) Journal entry example (IFRS):Warranty expected payout 80,000 (probability-weighted).

• Debit: Warranty Expense 80,000

• Credit: Provision for Warranties 80,000

4) Changes in estimates.Adjust provisions prospectively as new information arises.If discounted, unwind the discount each period:

• Debit: Finance Cost (unwinding) xx

• Credit: Provision xx

5) Reimbursements.Recognize a separate asset when reimbursement (e.g., insurance recovery) is virtually certain.

• Debit: Receivable – Insurance Reimbursement xx

• Credit: Gain on Reimbursement xx

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Recognition and measurement under US GAAP (ASC 450).

1) Recognition criteria.A loss contingency is recognized when:

• It is probable that a liability has been incurred, and

• The amount can be reasonably estimated.

If only one criterion is met → disclose; if neither → ignore.

2) Measurement.

• If a range of estimates exists and no amount within the range is a better estimate, recognize the minimum amount in the range.

• No discounting (except for asset retirement obligations under ASC 410).

Example — litigation loss:Probable loss estimated between 1,000,000 and 1,500,000.Recognize 1,000,000 (lower bound).

Journal entry:

• Debit: Litigation Expense 1,000,000

• Credit: Accrued Liability – Legal Case 1,000,000

3) Disclosure.Disclose nature, possible loss range, and uncertainties if a loss is reasonably possible.No recognition until probable.

4) Reimbursements.Recognize asset only if recovery is probable. Do not offset against liability in the balance sheet.

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Comparative table: IAS 37 vs ASC 450.

Aspect	IFRS (IAS 37)	US GAAP (ASC 450)
Recognition threshold	“Probable” = >50% likelihood	“Probable” = likely (~70–80%)
Measurement	Best estimate (expected value or most likely)	Minimum in range if no point estimate
Discounting	Required if material	Generally prohibited
Reimbursements	Recognize separate asset if virtually certain	Recognize separate asset if probable
Contingent liabilities	Disclose unless remote	Disclose if reasonably possible
Contingent assets	Recognize only when virtually certain	Recognize only when realized
Onerous contracts	Provision required for unavoidable loss	Handled under specific guidance (ASC 605-35 or ASC 450)
Restructuring	Provision only when detailed plan announced and valid expectation created	Recognized when communicated and incurred
Discount unwinding	Present as finance cost	Generally not applicable

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Common types of provisions.

1) Warranties.Recognize provision at sale date based on historical data of warranty claims.Journal entry:

• Debit: Warranty Expense xx

• Credit: Provision for Warranties xx

2) Restructuring.Recognize only when a detailed formal plan is approved and communicated to affected parties.

• Debit: Restructuring Expense xx

• Credit: Provision – Restructuring xx

3) Onerous contracts.If unavoidable costs exceed expected benefits, recognize provision for the excess.

• Debit: Loss on Onerous Contract xx

• Credit: Provision xx

4) Legal disputes.Record provision if outflow probable and estimable.Disclose range or uncertainty if only reasonably possible.

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Example calculation — expected value method (IFRS).

A company faces a potential environmental cleanup:

• 40% chance of paying 1,000,000

• 60% chance of paying 600,000

  
  

  Expected cost = (0.4 × 1,000,000) + (0.6 × 600,000) = 760,000.

  
  

  Discounted at 5% for one year = 723,810.

Journal entry:

• Debit: Environmental Expense 723,810

• Credit: Provision – Environmental Obligation 723,810

Next year, unwind discount:

• Debit: Finance Cost 36,190

• Credit: Provision – Environmental Obligation 36,190

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Disclosure examples.

Type of Provision	Opening Balance (USD)	Additions	Utilized	Released	Closing Balance (USD)
Warranties	500,000	180,000	(160,000)	(20,000)	500,000
Restructuring	—	250,000	(100,000)	—	150,000
Environmental	720,000	—	—	—	720,000

Disclose nature of obligation, expected timing of outflows, and uncertainties in estimation.

IFRS 37 additional requirements: sensitivity to key assumptions, reimbursements, and discount rates.

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Journal entries summary.

Recognition of provision:

• Debit: Expense xx

• Credit: Provision xx

Utilization:

• Debit: Provision xx

• Credit: Cash xx

Reversal (no longer required):

• Debit: Provision xx

• Credit: Expense xx

Reimbursement (IFRS/GAAP):

• Debit: Receivable xx

• Credit: Other Income / Offset xx

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Impact on financial performance and ratios.

Provisions directly reduce profit before tax and equity, but improve future comparability once settled. Excessive provisioning can distort earnings smoothing, while under-provisioning may signal aggressive reporting.Ratios affected include:

• Current ratio: provisions classified as current liabilities lower liquidity.

• Debt to equity: increases if large long-term provisions exist.

• EBITDA: unaffected, as provisions are non-cash charges.

Analysts focus on provision movements and contingent liability disclosures to assess transparency in risk reporting.

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Operational considerations.

Entities should establish a central register of legal and operational exposures, updated with risk assessments, historical claim rates, and probability models. Finance teams must coordinate with legal, compliance, and environmental departments to quantify potential obligations.Ensure that:

• Documentation supports obligation existence and estimation method.

• Discount rates align with pre-tax risk-free or market-based rates.

• Reversals are approved and clearly justified.

Consistent, evidence-based provisioning builds credibility and compliance with both IFRS and US GAAP standards.

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