Provisions, Contingent Liabilities and Employee Benefits
IAS 37 requires a provision where there is a present obligation from a past event, probable outflow of economic benefits, and a reliable estimate. Provisions are measured at the best estimate of the expenditure required to settle the obligation, discounted where the effect is material, and reviewed at each reporting date. Contingent liabilities are not recognised but disclosed unless the possibility of outflow is remote; contingent assets are not recognised and disclosed only where an inflow is probable. Onerous contracts and restructuring provisions have specific criteria: a constructive obligation arises only where a detailed formal plan exists and a valid expectation has been raised in those affected.
Traps
Candidates must distinguish provisions from contingent liabilities, and must handle the reimbursement right separately (recognised only when virtually certain, and capped at the provision). Watch for the treatment of future operating losses (no provision), the discounting of long-term provisions with the unwinding of the discount recognised in finance costs, and the distinction between IAS 19 employee benefits: short-term benefits, post-employment benefits (defined contribution versus defined benefit), other long-term benefits and termination benefits. Defined benefit accounting requires the projected unit credit method, actuarial gains and losses recognised in OCI, and the net interest approach.
Worked example / rule of thumb
A court case at year-end has a 60% probability of a $1,000,000 outflow and a 40% probability of no outflow. Because the outflow is probable and can be estimated, recognise a provision of $1,000,000 (the best estimate of the single obligation), not the expected value of $600,000. Rule of thumb: for a single obligation, use the most likely outcome; for a large population, use expected value.