IAS 37 · Manufacturing

IAS 37 Provision Calculator
for Manufacturing

Pre-configured for manufacturing provision types: product warranty calculations using expected value method, plant closure restructuring, environmental remediation for manufacturing sites, and onerous supply contracts.

Obligation Type

Present Obligation

Does a present obligation exist from a past event?

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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 Provisions in Manufacturing

Manufacturing entities carry some of the most diverse provision portfolios under IAS 37. Product warranty obligations are almost universal, representing a textbook application of the expected value measurement method described in IAS 37.39. Every manufactured product sold with a warranty creates an obligation that meets all three recognition criteria: a present obligation exists from the past event of selling the product, an outflow is probable when the warranty population is large enough for statistical certainty, and the amount can be reliably estimated using historical claim data. Beyond warranties, manufacturers face environmental remediation obligations for contaminated manufacturing sites, restructuring provisions when rationalising production capacity, onerous contract provisions when commodity price swings make fixed-price supply agreements loss-making, and product liability claims that can dwarf warranty provisions in both amount and complexity.

Measurement Considerations for Manufacturing

The expected value method is the cornerstone of warranty provision measurement in manufacturing. IAS 37.39 states that where there is a large population of items, the obligation is estimated by weighting all possible outcomes by their associated probabilities. For a manufacturer producing 100,000 units annually with a 2-year warranty, historical data might show that 2% of units develop minor defects (average repair cost €50), 0.5% develop moderate defects (average cost €200), and 0.1% develop major defects requiring replacement (average cost €500). The expected value calculation weights each outcome by its probability to produce the provision amount. This is fundamentally different from the single best estimate approach used for one-off obligations like a specific legal claim. Manufacturing auditors should verify that management's warranty provision model uses a sufficient lookback period of historical claims data (typically 3-5 years) and that the data is segmented by product line, as different products will have materially different defect rates and repair costs.

Regulatory Context and Audit Considerations

Environmental provisions for manufacturing sites are governed by both IAS 37 and IFRIC 1 (Changes in Existing Decommissioning, Restoration and Similar Liabilities). When a manufacturer has a legal obligation to remediate a contaminated site, the provision is recognised with a corresponding increase in the cost of the related property, plant and equipment under IAS 16.16(c). Subsequent changes in the estimated remediation cost adjust the asset cost, not profit or loss — unless the asset has been fully depreciated, in which case the full adjustment flows through the income statement. This is a frequently tested area in manufacturing audits because the linkage between the provision and the asset is often poorly documented. Restructuring provisions under IAS 37.70-83 require particular attention in manufacturing: a board decision to close a plant does not itself create a constructive obligation. The entity must have both a detailed formal plan and have raised a valid expectation in those affected.

Common Provision Types in Manufacturing

warranty

Product warranty claims covering defects in manufactured goods, typically assessed using expected value method across large claim populations

Typical: 1-5% of revenue Timeline: 1-3 years Method: Expected Value
product liability

Claims arising from product defects causing damage or injury, often involving significant legal costs and uncertain outcomes

Typical: Variable, often material Timeline: 2-5 years Method: Best Estimate
restructuring

Plant closures, production line discontinuation, employee redundancies — requires detailed formal plan communicated to affected parties

Typical: Severance + site closure costs Timeline: 6-18 months Method: Best Estimate
environmental

Site remediation for contamination from manufacturing processes — chemicals, heavy metals, industrial waste disposal

Typical: €500K-€50M Timeline: 5-20 years Method: Best Estimate
onerous contract

Fixed-price supply contracts where input costs (raw materials, energy) have risen above the contract revenue

Typical: Net loss on contract Timeline: Remaining contract term Method: Best Estimate

Worked Example: EuroParts Manufacturing GmbH

EuroParts produces automotive components and offers a 3-year warranty on all products. Based on 5 years of claims data across its product range, management identifies three possible outcomes for each unit sold:

Outcome Probability Amount
No defect — no cost 95% €0
Minor defect — warranty repair 3.5% €120
Major defect — full replacement 1.5% €450

Expected cost per unit = (95% × €0) + (3.5% × €120) + (1.5% × €450) = €0 + €4.20 + €6.75 = €10.95 per unit. Total provision = 80,000 units × €10.95 = €876,000. This warranty provision is recognised in full at the point of sale, with annual reassessment based on updated claims experience.

Provision Amount
€876.000
Regulatory Context: Manufacturing entities with operations in the EU should consider the Product Liability Directive (85/374/EEC) and national implementation laws when assessing the probability and amount of product liability provisions. Environmental obligations may arise under the Environmental Liability Directive (2004/35/CE) and national environmental legislation.

Frequently Asked Questions — Manufacturing

How should manufacturing warranty provisions be calculated under IAS 37?
Manufacturing warranty provisions are best calculated using the expected value method (IAS 37.39) because warranties typically cover a large population of items. Weight each possible outcome (no defect, minor defect, major defect) by its probability based on historical claims data. Multiply the expected cost per unit by the number of units under warranty. Reassess the provision at each reporting date using updated claims experience. Segment the analysis by product line because different products have materially different defect rates.
When does a manufacturing restructuring create a provision under IAS 37?
A manufacturing restructuring — such as a plant closure or production line discontinuation — creates a provision only when the entity has both (1) a detailed formal plan identifying the affected business units, locations, functions, approximate number of employees to be compensated, expenditures, and timing, and (2) raised a valid expectation in those affected by starting implementation or announcing the main features. A board decision alone is not sufficient (IAS 37.72). Costs of ongoing activities like retraining or marketing for remaining operations cannot be included.
How should environmental remediation provisions be measured for manufacturing sites?
Environmental remediation provisions for manufacturing sites are typically long-term obligations (5-20+ years) and must be discounted to present value when the time value effect is material (IAS 37.45). The provision is recognised with a corresponding increase in PP&E cost under IAS 16.16(c). Use site-specific environmental assessments to estimate remediation costs, apply a pre-tax discount rate, and review annually. Changes in estimate adjust the related asset under IFRIC 1, not profit or loss (unless the asset is fully depreciated).
How do commodity price changes affect onerous contract provisions in manufacturing?
When commodity price increases cause the unavoidable costs of meeting a fixed-price supply contract to exceed the expected revenue, the contract becomes onerous under IAS 37.66. The provision equals the lower of the cost of fulfilling the contract (minus expected revenue) and the penalty for terminating it. Since May 2020, the cost of fulfilling includes both incremental costs and an allocation of other directly related costs, not just incremental costs alone.
Should product liability claims be provisioned differently from warranty claims?
Yes. Product liability claims are typically one-off or small-population obligations best measured using the single best estimate method (IAS 37.40), unlike warranties which use expected value. Each material claim should be assessed individually considering the probability of an adverse outcome, the likely damages if the claim succeeds, legal costs, and the timing of resolution. The probability assessment directly affects whether the obligation is recognised (>50%) or only disclosed as a contingent liability.
What is the difference between a warranty provision under IAS 37 and a service warranty under IFRS 15?
Assurance-type warranties — which guarantee that a product complies with agreed-upon specifications — are accounted for under IAS 37 as a provision. Service-type warranties — which provide a service beyond the assurance that the product meets specifications (e.g., extended maintenance contracts sold separately or covering additional services) — are treated as a separate performance obligation under IFRS 15 and recognised as revenue over the service period. The distinction depends on whether the customer has the option to purchase the warranty separately.

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