Provision (Accounting)
In accounting,
provision means
a liability of uncertain timing or amount. This is an official definition of
International Accounting Standards Board, quoted from
IAS 37.
The need to record provisions arises from
accrual basis accounting and also from an accounting principle of prudence.
IAS 37 requires that all liabilities which are probable (i.e. with probability of occurring over 50%) are recorded in a balance sheet. The following are the criteria set in
International Financial Reporting Standards (IFRS), specifically IAS 37 (quotation).
An enterprise must recognise a provision if, and only if: [IAS 37.14]
* a present obligation (legal or constructive) has arisen as a result of a past event (the obligating event),
* payment is probable ('more likely than not'), and
* the amount can be estimated reliably.
Please, note that various local
GAAPs have different requirements.
Sometimes, a word
reserve is used in the same meaning as
provision. However, such use is not consistent with IFRS terminology. IFRS use the term
reserve differently - see the link to
Reserve (Accounting).
Some provisions are not presented on a liability side of the
balance sheet. Instead, they are shown as negative
assets, decreasing value of other assets of the company. They are mostly used when a book value of assets is higher than their
fair value, so the asset value shown in books is not realistic.
Provisions presented as liabilities:Provision for reorganisation / severance provision - this provision is recorded when a company announces a plan to change its organisation structure, which will incur significant costs, including termination of personnel
Litigation provision - represents expected or most probable result of a legal case against the company
Environmental provisions - recorded by enterprises which will incurr significant costs for cleaning the environment, due to pollution resulting from current activities
Dismantling / recultivation provisions - recorded when a company knows that after end of current activities, they will be obliged to incur significant costs to e.g. dismantle buildings, clean the site, safely close exhausted mines, get rid of dangerous materials etc.
Provision for employee (or post-employment) benefits - when a benefit system of the company comprises benefits for employees leaving the company, or even employees that already left the company, or the company has significant benefits based on length of service, they need to accrue the liabilities over the time of employment of each employee
Provisions presented as negative assets:Bad debt provision - provision decreasing the value of
receivables, because their recoverability is doubtful. Mostly recorded based on aging of the receivables, older receivables are more doubtful that new ones.
Provision for product returns / credit note provision - provision decreasing the value of receivables due to expected sales returns. Normally recorded based on historical experience as a percentage of recent sales.
Market valuation provision - also called market valuation reserve, is used to decrease a value of
inventory, when its market price is lower than its current book (accounting) value
Provision for excessive, obsolete or damaged inventory - decreasing the value of inventory with uncertain marketability (due to its obsoletness, damages or excessive volume on stock)
Impairment provisions - generally any provisions recorded when a book value of an asset is significantly higher than its
fair value
