IAS 37

Provision
Calculator

Assess whether to recognise, disclose, or take no action — then calculate the provision amount with discounting, journal entries, and disclosure checklist.

Obligation Type

Present Obligation

Does a present obligation exist from a past event?

IAS 37 Provision Assessment Toolkit — free PDF

Complete audit toolkit: IAS 37 recognition decision flowchart, measurement methodology guide, discounting worked examples, disclosure checklist, provision type cheat sheet, and journal entry templates.

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IAS 37.14 — A provision shall be recognised when: (a) an entity has a present obligation from a past event; (b) it is probable that an outflow will be required; (c) a reliable estimate can be made.

IAS 37.36 — The amount recognised shall be the best estimate of the expenditure required to settle the present obligation at the end of the reporting period.

IAS 37.39 — Where there is a large population of items, the obligation is estimated by weighting all possible outcomes by their associated probabilities (expected value).

IAS 37.45 — Where the effect of the time value of money is material, the amount of a provision shall be the present value of the expenditures expected to settle the obligation.

IAS 37.72 — A constructive obligation to restructure arises only when an entity has a detailed formal plan and has raised a valid expectation in those affected.

IAS 37 Recognition Criteria — The Three-Part Test

IAS 37 Provisions, Contingent Liabilities and Contingent Assets establishes the framework for recognising and measuring provisions — liabilities of uncertain timing or amount. The standard applies to all provisions except those within the scope of another standard (such as IFRS 9 for financial instrument impairment, IFRS 17 for insurance contracts, or IAS 19 for employee benefits). A provision is recognised on the balance sheet only when all three criteria in IAS 37.14 are satisfied simultaneously.

(a) Present Obligation from a Past Event

The first criterion requires that a present obligation — legal or constructive — exists as a result of a past event. A legal obligation derives from a contract, legislation, or other operation of law (IAS 37.10). A constructive obligation derives from an entity's actions: an established pattern of past practice, published policies, or a sufficiently specific current statement that creates a valid expectation in other parties that the entity will discharge certain responsibilities (IAS 37.10). The past event that gives rise to the obligation is called the obligating event — it is an event that creates an obligation that the entity has no realistic alternative to settling (IAS 37.17).

(b) Probable Outflow of Resources

The second criterion is that it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation. IAS 37 defines "probable" as "more likely than not" — meaning strictly greater than 50% probability. This threshold is critical: an obligation assessed at exactly 50% probability does not meet the recognition threshold and should instead be disclosed as a contingent liability. The probability assessment should be based on all available evidence, including expert opinions, legal advice, and historical experience with similar obligations. For restructuring provisions, the probability assessment can only be made after the detailed formal plan exists and has been communicated to those affected (IAS 37.72).

(c) Reliable Estimate of Amount

The third criterion requires that a reliable estimate can be made of the amount of the obligation. IAS 37.25 notes that it is only in extremely rare cases that a reliable estimate cannot be made — the use of estimates is an essential part of the preparation of financial statements and does not undermine their reliability. Where a reliable estimate cannot be made (extremely rare), the obligation is disclosed as a contingent liability. The standard provides two measurement methods: the expected value method for large populations (IAS 37.39) and the single best estimate for individual obligations (IAS 37.40).

Measurement Methodology

Expected Value Method (IAS 37.39)

When a provision involves a large population of items — such as product warranty claims, customer return provisions, or product recall obligations — the expected value method produces the most reliable measurement. The provision is calculated by weighting each possible outcome by its associated probability and summing the results: Provision = Σ(probabilityi × amounti). For example, a manufacturer selling 50,000 units with a 3-year warranty might estimate that 95% of units will have no defects (€0 cost), 3% will have minor defects (€100 repair), and 2% will have major defects (€400 replacement). The expected cost per unit is (0.95 × €0) + (0.03 × €100) + (0.02 × €400) = €11, giving a total provision of €550,000.

Single Best Estimate (IAS 37.40)

For a single obligation — such as a specific legal claim or a one-off restructuring programme — the provision is measured at the single most likely outcome. However, the entity must still consider other possible outcomes: if the range of possible outcomes is skewed toward higher amounts, the best estimate should be adjusted upward; if skewed toward lower amounts, adjusted downward. This ensures the provision reflects the full range of risk, not just the modal outcome.

Present Value Discounting (IAS 37.45-47)

When the effect of the time value of money is material — typically for provisions settling more than one year from the reporting date — the provision must be measured at its present value: PV = FV / (1 + r)n, where r is the pre-tax discount rate reflecting current market assessments of the time value of money and risks specific to the liability, and n is the number of years to expected settlement. The discount rate must not reflect risks for which future cash flow estimates have already been adjusted, and must not reflect the entity's own credit risk. The unwinding of the discount is recognised as a finance cost each period: Interest expense = Opening provision × discount rate.

Specific Provision Types

Restructuring Provisions (IAS 37.70-83)

A constructive obligation to restructure arises only when an entity has both a detailed formal plan — identifying the affected business, principal locations, approximate number of employees to be compensated, expenditures, and timing — and has raised a valid expectation in those affected by starting implementation or announcing the main features. A management or board decision alone does not create an obligation (IAS 37.72). The provision may only include direct expenditures necessarily entailed by the restructuring: employee severance, lease termination costs, and asset write-downs. Costs of ongoing activities — retraining retained staff, marketing, and investment in new systems — are excluded even if incurred as a consequence of the restructuring.

Warranty Provisions

Product warranty provisions represent the textbook application of the expected value method. Large populations of warranty obligations allow statistical estimation based on historical claims data. Auditors should verify that the claims data is segmented by product line and covers a sufficient lookback period (typically 3-5 years). A critical distinction exists between assurance-type warranties (within IAS 37 — they guarantee the product meets specifications) and service-type warranties (within IFRS 15 — they provide a service beyond assurance and are treated as a separate performance obligation).

Onerous Contracts (IAS 37.66-69)

An onerous contract is one where the unavoidable costs of meeting the contractual obligations exceed the expected economic benefits. The provision equals the lower of the cost of fulfilling the contract (minus expected revenue) and the penalty for terminating it. Following the May 2020 amendment (effective 1 January 2022), the cost of fulfilling includes both incremental costs and an allocation of other costs that relate directly to fulfilling the contract — not just incremental costs alone. This change increased the number of contracts identified as onerous and the size of provisions.

Environmental and Decommissioning Provisions

Environmental remediation and asset decommissioning provisions are often long-term obligations spanning 10-50 years, making discounting critically important. The provision is recognised with a corresponding increase in the cost of the related property, plant and equipment under IAS 16.16(c). Changes in estimate are governed by IFRIC 1: increases or decreases in the estimated obligation adjust the related asset's carrying amount, with the adjustment depreciated over the remaining useful life. If the asset has been fully depreciated, the full change flows through profit or loss. The dramatic difference between nominal and present value amounts for long-horizon provisions must be clearly disclosed.

Legal Claims

Legal claim provisions typically use the single best estimate method. Each material claim should be assessed individually based on legal advice covering the probability of an adverse outcome, the likely damages or settlement amount, and legal costs. The probability assessment directly determines whether the claim is recognised (greater than 50%) or disclosed as a contingent liability (10-50%). Claims assessed as remote (below approximately 10%) require no disclosure. Legal privilege considerations may limit the specificity of disclosure under IAS 37.92 in extremely rare cases where disclosure would seriously prejudice the entity's position.

Disclosure Requirements (IAS 37.84-92)

IAS 37 requires comprehensive disclosure for each class of provision. The movement schedule — showing opening balance, additions, amounts used, reversals, unwinding of discount, and closing balance — is the centrepiece of provision disclosure. Beyond the quantitative reconciliation, entities must provide a brief description of the nature of the obligation, the expected timing of outflows, an indication of the uncertainties about the amount or timing, and the amount of any expected reimbursement stating the amount of any asset that has been recognised. For contingent liabilities (unless remote), the same descriptive information is required plus an estimate of the financial effect. In extremely rare cases, IAS 37.92 permits non-disclosure where disclosure would seriously prejudice the entity's position in a dispute — in such cases, the general nature of the dispute must still be disclosed along with the fact that information has been withheld and the reason.

Worked Example: Two Provisions in Practice

Example 1: Warranty Provision (Expected Value)

EuroTech Manufacturing AG sold 60,000 units during the year with a 2-year warranty. Five years of historical claims data reveals the following pattern:

Outcome Probability Cost per Unit Weighted
No defect 94.0% €0 €0.00
Minor defect (repair) 4.0% €85 €3.40
Major defect (replace) 2.0% €380 €7.60
Expected cost per unit €11.00

Total warranty provision = 60,000 units × €11.00 = €660,000. Journal entry: Dr Warranty expense €660,000 / Cr Warranty provision €660,000. The provision is reassessed at each reporting date using updated claims data.

Example 2: Environmental Provision (Discounted)

EuroTech Manufacturing AG also has a legal obligation to remediate a contaminated manufacturing site. Environmental engineers estimate the remediation cost at €5,000,000 at current prices, with completion expected in 15 years.

Discount rate: 3.5% (pre-tax, reflecting time value and obligation-specific risk).
PV = €5,000,000 / (1.035)15 = €5,000,000 / 1.6753 = €2,984,600.

Journal entry: Dr PP&E (manufacturing site) €2,984,600 / Cr Environmental provision €2,984,600.
Year 1 unwinding: Dr Finance costs €104,461 / Cr Environmental provision €104,461.

The nominal cost of €5,000,000 and the present value of €2,984,600 are both disclosed, clearly showing the €2,015,400 discount effect. Each year, the discount unwinds as a finance cost, gradually increasing the provision toward the nominal amount as the settlement date approaches.

Frequently Asked Questions

What are the three recognition criteria for a provision under IAS 37?
IAS 37.14 requires all three conditions to be met: (a) a present obligation (legal or constructive) exists as a result of a past event, (b) it is probable (more likely than not, meaning greater than 50%) that an outflow of resources embodying economic benefits will be required to settle the obligation, and (c) a reliable estimate can be made of the amount of the obligation. If all three are met, a provision is recognised on the balance sheet. If the outflow is possible but not probable, the obligation is disclosed as a contingent liability. If the outflow is remote, no disclosure is required.
What is the difference between the expected value and best estimate methods in IAS 37?
IAS 37 prescribes two measurement approaches depending on the population of obligations. The expected value method (IAS 37.39) is used when there is a large population of items — such as warranty claims or product returns — where the provision is estimated by weighting all possible outcomes by their associated probabilities. The single best estimate method (IAS 37.40) is used for a single obligation — such as a specific legal claim — where the provision is the single most likely outcome, adjusted if the range of other outcomes is predominantly higher or lower. The expected value method produces a probability-weighted average, while the best estimate focuses on the most probable individual outcome.
When is discounting required for provisions under IAS 37?
IAS 37.45-47 requires discounting when the effect of the time value of money is material. This is typically the case when the provision is expected to be settled more than one year from the reporting date. The discount rate must be a pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the liability. The entity's own credit risk must not be reflected in the discount rate. For short-term provisions (settling within one year), discounting is typically not required because the time value effect is immaterial. The unwinding of the discount is recognised as a finance cost each period.
What is the difference between a provision and a contingent liability?
A provision is a liability of uncertain timing or amount that meets all three recognition criteria and is recognised on the balance sheet (IAS 37.14). A contingent liability is either (a) a possible obligation arising from past events whose existence will be confirmed by uncertain future events not wholly within the entity's control, or (b) a present obligation that does not meet the recognition criteria because an outflow is not probable or cannot be reliably estimated (IAS 37.10). Contingent liabilities are disclosed in the notes to the financial statements but not recognised on the balance sheet, unless the outflow is remote, in which case no disclosure is required.
How does the May 2020 amendment to IAS 37 affect onerous contract provisions?
The May 2020 amendment to IAS 37 (effective 1 January 2022) clarified that the 'cost of fulfilling' a contract includes both costs that relate directly to the contract — specifically, both incremental costs of fulfilling the contract (such as direct labour and materials) and an allocation of other costs that relate directly to fulfilling contracts (such as depreciation of equipment used to fulfil the contract, and costs of contract management and supervision). This overturned the previous practice of some entities that included only incremental costs, which produced a lower cost estimate and triggered fewer onerous contract provisions. The amendment increased the number of contracts identified as onerous and the size of onerous contract provisions.
What are the IAS 37.72 requirements for restructuring provisions?
IAS 37.72 states that a constructive obligation to restructure arises only when an entity has both (a) a detailed formal plan for the restructuring, identifying at least the business or part of a business concerned, the principal locations affected, the location, function and approximate number of employees who will be compensated for terminating their services, the expenditures that will be undertaken, and when the plan will be implemented; and (b) raised a valid expectation in those affected that it will carry out the restructuring by starting to implement that plan or announcing its main features to those affected. A management or board decision alone does not create a constructive obligation — communication or implementation must have begun.
How should reimbursements be treated under IAS 37?
IAS 37.53-58 addresses reimbursements: when some or all of the expenditure required to settle a provision is expected to be reimbursed by another party (e.g., through insurance or supplier indemnities), the reimbursement is recognised as a separate asset only when it is virtually certain that reimbursement will be received. This is a higher threshold than the 'probable' test for provision recognition. The reimbursement asset must not exceed the amount of the provision. Critically, IAS 37.54 requires gross presentation: the provision and the reimbursement asset must be shown separately on the balance sheet — they cannot be netted off against each other. In the income statement, the provision expense may be presented net of the reimbursement.
What disclosures are required for provisions under IAS 37.84-92?
IAS 37.84 requires disclosure for each class of provision: the carrying amount at the beginning and end of the period, additional provisions made (including increases to existing provisions), amounts used (charged against the provision), unused amounts reversed, the increase during the period from the unwinding of discount and any changes in discount rate. IAS 37.85 requires a brief description of the nature of the obligation, expected timing, uncertainties, and major assumptions. IAS 37.86-89 require disclosure of contingent liabilities (unless remote) including nature, financial effect estimate, uncertainties, and reimbursement possibilities. IAS 37.92 permits non-disclosure in extremely rare cases where disclosure would seriously prejudice the entity's position in a dispute.
What is the probability threshold for recognising a provision versus disclosing a contingent liability?
IAS 37 uses 'probable' as the recognition threshold, defined as 'more likely than not' — meaning strictly greater than 50%. At exactly 50%, the obligation does not meet the probable threshold and should be disclosed as a contingent liability rather than recognised as a provision. Below approximately 10% probability, the outflow is considered 'remote' and no disclosure is required. Between 10% and 50% — the 'possible' range — the obligation is disclosed as a contingent liability in the notes to the financial statements. Above 50%, the provision is recognised on the balance sheet provided the other two recognition criteria (present obligation and reliable estimate) are also met.
How does IAS 37 interact with IFRIC 1 for decommissioning provisions?
IFRIC 1 addresses changes in existing decommissioning, restoration and similar liabilities that are within the scope of IAS 37 and are also included in the cost of a related asset under IAS 16. When the estimated cost of decommissioning changes (due to revised cost estimates, changes in discount rate, or changes in timing), IFRIC 1 requires the adjustment to be added to or deducted from the cost of the related asset. The adjusted asset cost is then depreciated prospectively over the remaining useful life. If the asset has already been fully depreciated, the full adjustment is recognised in profit or loss. This ensures that changes in decommissioning estimates affect the income statement through depreciation rather than as an immediate gain or loss.

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IAS 37.14 — A provision shall be recognised when the entity has a present obligation as a result of a past event, it is probable that an outflow of resources will be required, and a reliable estimate can be made.

IAS 37.36 — The amount recognised as a provision shall be the best estimate of the expenditure required to settle the present obligation at the end of the reporting period.

IAS 37.45 — Where the effect of the time value of money is material, the amount of a provision shall be the present value of the expenditures expected to be required to settle the obligation.

IAS 37.72 — A constructive obligation to restructure arises only when an entity has a detailed formal plan and has raised a valid expectation in those affected.