discloses a contingent liability, unless the possibility of an outflow of resources embodying economic benefits
is remote (see paragraph 68) .
16. A past event that leads to a present obligation is called an obligating event. For an event to be an obligating event, it is necessary that
the enterprise has no realistic alternative to settling the obligation created by the event.
17.Financial statements deal with the financial position of an enterprise at the end of its reporting
period and not its possible position in the future. Therefore, no provision is recognised for costs that need to be
incurred to operate in the future. The only liabilities recognised in an enterprise’s balance sheet are those that
exist at the balance sheet date.
18. It is only those obligations arising from past events existing independently of an enterprise’s future actions
(i.e. the future conduct of its business) that are recognised as provisions. Examples of such obligations are
penalties or clean-up costs for unlawful environmental damage, both of which would lead to an outflow of resources
embodying economic benefits in settlement regardless of the future actions of the enterprise. Similarly, an
enterprise recognises a provision for the decommissioning costs of an oil installation to the extent that the
enterprise is obliged to rectify damage already caused. In contrast, because of commercial pressures or legal
requirements, an enterprise may intend or need to carry out expenditure to operate in a particular way in the future
(for example, by fitting smoke filters in a certain type of factory). Because the enterprise can avoid the future
expenditure by its future actions, for example by changing its method of operation, it has no present obligation for
that future expenditure and no provision is recognised.
19. An obligation always involves another party to whom the obligation is owed. It is not necessary,
however, to know the identity of the party to whom the obligation is owed – indeed the obligation may be to the
20. An event that does not give rise to an obligation immediately may do so at a later date, because of
changes in the law. For example, when environmental damage is caused there may be no obligation to remedy the
consequences. However, the causing of the damage will become an obligating event when a new law requires the
existing damage to be rectified.
21. Where details of a proposed new law have yet to be finalised, an obligation arises only when the legislation is
virtually certain to be enacted. Differences in circumstances surrounding enactment usually make it impossible to
specify a single event that would make the enactment of a law virtually certain. In many cases it will be impossible
to be virtually certain of the enactment of a law until it is enacted.
Probable Outflow of Resources Embodying Economic Benefits
22. For a liability to qualify for recognition there must be not only a present obligation but also the probability
of an outflow of resources embodying economic benefits to settle that obligation. For the purpose of this Standard
3 , an outflow of resources or other event is regarded as probable if the event is more likely than not to
occur, i.e., the probability that the event will occur is greater than the probability that it will not. Where it is
not probable that a present obligation exists, an enterprise discloses a contingent liability, unless the
possibility of an outflow of resources embodying economic benefits is remote (see paragraph 68) .
23. Where there are a number of similar obligations (e.g. product warranties or similar contracts) the probability
that an outflow will be required in settlement is determined by considering the class of obligations as a whole.
Although the likelihood of outflow for any one item may be small, it may well be probable that some outflow of
resources will be needed to settle the class of obligations as a whole. If that is the case, a provision is
recognised (if the other recognition criteria are met).
Reliable Estimate of the Obligation
24. The use of estimates is an essential part of the preparation of financial statements and does not undermine their
reliability. This is especially true in the case of provisions, which by their nature involve a greater degree of
estimation than most other items. Except in extremely rare cases, an enterprise will be able to determine a range of
possible outcomes and can therefore make an estimate of the obligation that is reliable to use in recognising a
25. In the extremely rare case where no reliable estimate can be made, a liability exists that cannot be recognised.
That liability is disclosed as a contingent liability (see paragraph
26. An enterprise should not recognise a contingent liability.
27. A contingent liability is disclosed, as required by paragraph 68,
unless the possibility of an outflow of resources embodying economic benefits is remote.
28. Where an enterprise is jointly and severally liable for an obligation, the part of
the obligation that is expected to be met by other parties is treated as a contingent liability. The enterprise
recognises a provision for the part of the obligation for which an outflow of resources embodying economic benefits
is probable, except in the extremely rare circumstances where no reliable estimate can be made (see paragraph 14 ).
29. Contingent liabilities may develop in a way not initially expected. Therefore, they are assessed continually to
determine whether an outflow of resources embodying economic benefits has become probable. If it becomes probable
that an outflow of future economic benefits will be required for an item previously dealt with as a contingent
liability, a provision is recognised in accordance with paragraph 14 in the financial statements of the period in
which the change in probability occurs (except in the extremely rare circumstances where no reliable estimate can be
30. An enterprise should not recognise a contingent asset.
31. Contingent assets usually arise from unplanned or other unexpected events that give rise to the possibility of an
inflow of economic benefits to the enterprise. An example is a claim that an enterprise is pursuing through legal
processes, where the outcome is uncertain.
32. Contingent assets are not recognised in financial statements since this may result in the recognition of income
that may never be realised. However, when the realisation of income is virtually certain, then the related asset is
not a contingent asset and its recognition is appropriate.
33. A contingent asset is not disclosed in the financial statements. It is usually disclosed in the report of the
approving authority (Board of Directors in the case of a company, and, the corresponding approving authority in the
case of any other enterprise), where an inflow of economic benefits is probable.
34. Contingent assets are assessed continually and if it has become virtually certain that an inflow of economic
benefits will arise, the asset and the related income are recognised in the financial statements of the period in
35. The amount recognised as a provision should be the best estimate of
the expenditure required to settle the present obligation at the balance sheet date. The amount of a provision
should not be discounted to its present value except in case of decommissioning, restoration and similar liabilities
that are recognised as cost of Property, Plant and Equipment. The discount rate (or rates) should be a pre-tax rate
(or rates) that reflect(s) current market assessments of the time value of money and the risks specific to the
liability. The discount rate(s) should not reflect risks for which future cash flow estimates have been adjusted.
Periodic unwinding of discount should be recognised in the statement of profit and loss.
36. The estimates of outcome and financial effect are determined by the judgment of the management of the enterprise,
supplemented by experience of similar transactions and, in some cases, reports from independent experts. The
evidence considered includes any additional evidence provided by events after the balance sheet date.
37. The provision is measured before tax; the tax consequences of the provision, and changes in it, are dealt with
under AS 22, Accounting for Taxes on Income .
38. The risks and uncertainties that inevitably surround many events and circumstances should be taken
into account in reaching the best estimate of a provision.
39. Risk describes variability of outcome. A risk adjustment may increase the amount at which a liability is
measured. Caution is needed in making judgments under conditions of uncertainty, so that income or assets are not
overstated and expenses or liabilities are not understated. However, uncertainty does not justify the creation of
excessive provisions or a deliberate overstatement of liabilities. For example, if the projected costs of a
particularly adverse outcome are estimated on a prudent basis, that outcome is not then deliberately treated as more
probable than is realistically the case. Care is needed to avoid duplicating adjustments for risk and uncertainty
with consequent overstatement of a provision.
40. Disclosure of the uncertainties surrounding the amount of the expenditure is made under paragraph 67(b).
41. Future events that may affect the amount required to settle an obligation should be reflected in
the amount of a provision where there is sufficient objective evidence that they will occur.
42. Expected future events may be particularly important in measuring provisions. For example, an enterprise may
believe that the cost of cleaning up a site at the end of its life will be reduced by future changes in technology.
The amount recognised reflects a reasonable expectation of technically qualified, objective observers, taking
account of all available evidence as to the technology that will be available at the time of the clean-up. Thus, it
is appropriate to include, for example, expected cost reductions associated with increased experience in applying
existing technology or the expected cost of applying existing technology to a larger or more complex clean-up
operation than has previously been carried out. However, an enterprise does not anticipate the development of a
completely new technology for cleaning up unless it is supported by sufficient objective evidence.
43. The effect of possible new legislation is taken into consideration in measuring an existing obligation when
sufficient objective evidence exists that the legislation is virtually certain to be enacted. The variety of
circumstances that arise in practice usually makes it impossible to specify a single event that will provide
sufficient, objective evidence in every case. Evidence is required both of what legislation will demand and of
whether it is virtually certain to be enacted and implemented in due course. In many cases sufficient objective
evidence will not exist until the new legislation is enacted.
Expected Disposal of Assets
44. Gains from the expected disposal of assets should not be taken into
account in measuring a provision.
45. Gains on the expected disposal of assets are not taken into account in measuring a
provision, even if the expected disposal is closely linked to the event giving rise to the provision. Instead, an
enterprise recognises gains on expected disposals of assets at the time specified by the Accounting Standard dealing
with the assets concerned.
46. Where some or all of the expenditure required to settle a provision
is expected to be reimbursed by another party, the reimbursement should be recognised when, and only when, it is
virtually certain that reimbursement will be received if the enterprise settles the obligation. The reimbursement
should be treated as a separate asset. The amount recognised for the reimbursement should not exceed the amount of
47. In the statement of profit and loss, the expense relating to a
provision may be presented net of the amount recognised for a reimbursement.
48. Sometimes, an enterprise is able to look to another party to pay part or all of the expenditure required to
settle a provision (for example, through insurance contracts, indemnity clauses or suppliers’ warranties). The other
party may either reimburse amounts paid by the enterprise or pay the amounts directly.
49. In most cases, the enterprise will remain liable for the whole of the amount in question so that the enterprise
would have to settle the full amount if the third party failed to pay for any reason. In this situation, a provision
is recognised for the full amount of the liability, and a separate asset for the expected reimbursement is
recognised when it is virtually certain that reimbursement will be received if the enterprise settles the liability.
50. In some cases, the enterprise will not be liable for the costs in question if the third party fails to pay. In
such a case, the enterprise has no liability for those costs and they are not included in the provision.
51. As noted in paragraph 28 , an obligation for which an enterprise is
jointly and severally liable is a contingent liability to the extent that it is expected that the obligation will be
settled by the other parties.
52. Provisions should be reviewed at each balance sheet date and adjusted to reflect the current best
estimate. If it is no longer probable that an outflow of resources embodying economic benefits will be required to
settle the obligation, the provision should be reversed.
53. A provision should be used only for expenditures for which the provision was originally recognised.
54. Only expenditures that relate to the original provision are adjusted against it. Adjusting expenditures against a
provision that was originally recognised for another purpose would conceal the impact of two different events.
Application of the Recognition and Measurement Rules
55. Provisions should not be recognised for future operating losses.
56. Future operating losses do not meet the definition of a liability in
paragraph 10 and the general recognition criteria set out for provisions in paragraph 14 .
57. An expectation of future operating losses is an indication that certain assets of the operation may be impaired.
An enterprise tests these assets for impairment under Accounting Standard (AS) 28, Impairment of Assets .
58. The following are examples of events that may fall under the definition of restructuring:
