Provisions and contingencies

Some obligations are certain in amount and date — a supplier invoice, a loan repayment. Others are not: a lawsuit, a warranty, a site that must eventually be restored. Ind AS 37 governs the second kind.

The definition

A provision is a liability of uncertain timing and amount.

That is the distinction from a trade payable, which is a liability of known timing and amount. The uncertainty is what requires a standard.

The three conditions

ICAI states them plainly. A provision shall be recognised when:

1. an entity has a present obligation (legal or constructive) that is a result of a past event;
2. it is probable that an outflow of resources embodying economic benefits will be required to settle it; and
3. a reliable estimate can be made of the amount.

If these conditions are not met, no provision shall be recognised. All three, not any of them.

Two words carry most of the weight. Present obligation from a past event — so a cost the company expects to incur next year because it intends to, with no obligation yet, is not a provision. Future operating losses are not provided for: there is no past event.

Constructive obligation widens it usefully. A company with an established practice of refunding customers beyond its legal duty has created an expectation, and that can be an obligation even without a contract.

The ladder

What happens to an obligation depends on where it sits on a scale of likelihood:

Likelihood	Treatment
Probable, estimable	Provision — recognised on the balance sheet, charged to profit
Possible, or probable but not estimable	Contingent liability — disclosed in the notes only
Remote	Neither recognised nor disclosed

The middle row is where bad news lives. A contingent liability does not touch the balance sheet or profit. It appears only in a note, and it is a real obligation that the company judges unlikely enough, or too uncertain, to recognise.

The judgement is management's, and the gap between "probable" and "possible" is not a number.

Why Indian reports deserve a careful read here

Contingent liability notes in large Indian companies routinely contain substantial disputed tax demands — the company has been assessed, disagrees, and is litigating. These are not provisions because the company believes it will win.

Sometimes it does. The useful exercise is the one in the problem: total them and compare to net worth. If the total is a large fraction of equity, the accounts contain a tail risk that no line on the balance sheet reports. That is not an accusation of wrongdoing; it is the note doing exactly its job, for a reader who opens it.

Review, and the ways it is used

Provisions are reviewed at the end of each reporting period and adjusted to the current best estimate. If an outflow is no longer probable, the provision is reversed.

That reversal goes to profit. Which creates two patterns worth knowing:

Over-providing in a good year builds a cushion that can be released into a weak one. The release looks like operating performance and is not.

Under-providing keeps profit high now and leaves the obligation to surface later, usually larger.

Both are chapter 15's territory. The honest signal is a provisions movement table — opening balance, charged, utilised, reversed, closing — which Ind AS requires. A large reversed column in a year of weak operating results is a question worth asking.

The point

A provision is a liability of uncertain timing and amount, recognised only when there is a present obligation from a past event, an outflow is probable, and the amount can be reliably estimated. Fail any of the three and it becomes a contingent liability disclosed in the notes alone — which is where disputed tax demands and litigation sit, outside the balance sheet entirely. Provisions are re-estimated each period, and a reversal flows to profit, so the movement table matters more than the closing balance.