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Provisions: creation and features
Edexcel IAL Accounting · WAC12 Corporate and Management Accounting
A provision is a liability of uncertain timing or amount. Making one applies prudence and the accruals concept: an expected cost is recognised when the obligation arises, not when the cash is paid.
What a provision is
IAS 37 defines a provision as a liability of uncertain timing or amount. A provision is recognised only when:
- the company has a present obligation (legal or constructive) as a result of a past event
- an outflow of resources is probable (more likely than not), and
- a reliable estimate of the amount can be made.
Examples: product warranties, a legal claim the company expects to lose, costs of restoring a site, a restructuring already announced.
Creating and changing a provision
Create or increase: Dr the relevant expense (statement of profit or loss), Cr Provision (liability in the statement of financial position: current or non-current depending on timing).
Use: when the cost is paid, Dr Provision, Cr Bank (no further expense).
Decrease: if less is needed, Dr Provision, Cr statement of profit or loss (reduces expenses).
Provisions are reviewed at each year end and adjusted to the best estimate.
Provisions, allowances and reserves
| Provision (IAS 37) | Allowance for depreciation or irrecoverable debts | Reserve | |
|---|---|---|---|
| What it is | A liability: an amount the company expects to pay | A reduction in the value of an asset | Part of equity: profits or gains belonging to shareholders |
| Created by | A charge (expense) against profit | A charge (expense) against profit | An appropriation of profit or a capital transaction |
| Shown | Liabilities | Deducted from the asset | Equity |
Contingent liabilities
If the outflow is only possible (not probable), or cannot be estimated reliably, no provision is made. It is a contingent liability, disclosed in a note unless the chance of payment is remote.
Worked example
A company sells goods with a one-year warranty. Past experience suggests repairs on this year's sales will cost £45,000. Last year's provision was £38,000. What entry is needed?
- The provision must rise from £38,000 to £45,000
- Increase = £7,000
- Dr Warranty expense £7,000, Cr Provision for warranties £7,000
Answer: Charge £7,000 to profit; the provision of £45,000 is shown as a liability
Check yourself
- A provision for legal claims stands at £120,000. The best estimate at the year end is £155,000. What expense is charged in this year's statement of profit or loss?
Show answer
£35000. Increase = 155,000 - 120,000 = £35,000.
- A warranty provision of £60,000 is reduced to £48,000 at the year end. By how much does this change increase profit?
Show answer
£12000. The £12,000 reduction is credited to the statement of profit or loss.
- Which best defines a provision under IAS 37?
- Profits set aside for future dividends
- Cash kept in a separate bank account
- A liability of uncertain timing or amount
- An amount owed to the company by customers
Show answer
A liability of uncertain timing or amount. That is the IAS 37 definition.
- A customer may sue a company, but the lawyers think it is unlikely the company will lose. What should the company do?
- Create a provision for the full claim
- Disclose a contingent liability in a note
- Create a general reserve
- Ignore it completely, even if the amount is large
Show answer
Disclose a contingent liability in a note. The outflow is possible but not probable, so no provision; disclose it as a contingent liability (unless remote).
- Which entry creates a provision for restructuring costs?
- Dr Provision, Cr Restructuring expense
- Dr Retained earnings, Cr General reserve
- Dr Bank, Cr Provision
- Dr Restructuring expense, Cr Provision
Show answer
Dr Restructuring expense, Cr Provision. An expense is charged and a liability created.
- How does a provision differ from a reserve?
- A provision is part of equity; a reserve is a liability
- A provision is a charge against profit shown as a liability; a reserve is part of equity
- Each is a cash balance held at the bank
- A reserve reduces profit; a provision does not
Show answer
A provision is a charge against profit shown as a liability; a reserve is part of equity. Provisions are expenses and liabilities; reserves belong to shareholders.
Sources
Last updated 8 November 2026. Spotted a mistake? Tell us.