Key Difference between Provision and Contingent Liability

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The concept Difference between Provision and Contingent Liability DESCRIBES that ‘Provision‘ is a liability that is recognized in the financial statements when a company has a probable obligation or a present obligation and ‘Contingent Liability‘ is a potential liability that may arise from past events but is uncertain in terms of its timing or amount.

What is Provision?

A Provision is a liability that is recognized in the financial statements when a company has a probable obligation or a present obligation that is likely to result in an outflow of resources, AND the amount of the obligation can be estimated with reasonable accuracy.

A Provision is a liability because the company owes something to someone else, and it is RECOGNIZED in the financial statements because it is expected that the company will have to pay the amount of the obligation in the future.

A Provision is RECOGNIZED in the financial statements when all of the following conditions are met:

  • The company has a Present Obligation as a result of a past event;
  • It is probable that an Outflow of Resources will be required to settle the obligation; AND
  • The Amount of the Obligation can be estimated with reasonable accuracy.

Provisions are COMMONLY used in accounting for items such as Warranties, Bad Debts, Restructuring Costs, and Legal Claims. These are all items that the company knows it will have to pay for in the future, and can reasonably estimate the amount it will have to pay.

What is Contingent Liability?

A Contingent Liability is a potential liability that may arise from past events but is uncertain in terms of its timing or amount. In other words, a Contingent Liability is a possible obligation that may or may not arise, and the amount of the obligation is uncertain. Contingent Liabilities are NOT recognized in the financial statements but are DISCLOSED in the notes to the financial statements.

There are THREE types of Contingent Liabilities:

  • Possible Contingent Liabilities: These are potential obligations that may arise from past events, but the likelihood of the obligation arising is LESS than probable.
  • Probable Contingent Liabilities: These are potential obligations that may arise from past events, and the likelihood of the obligation arising is MORE than possible but less than virtually certain.
  • Virtually Certain Contingent Liabilities: These are potential obligations that may arise from past events, AND the likelihood of the obligation arising is very high.

Examples of Contingent Liabilities INCLUDE pending Lawsuits, Product Warranties, and Environmental Liabilities. These are all items that the company is aware of, but the amount and timing of the obligation are uncertain.

difference between provision and contingent liability
Difference between Provision and Contingent Liability

Difference between Provision and Contingent Liability

The MAIN Difference is that a Provision is a liability that is recognized in the financial statements, while a Contingent Liability is a potential liability that is not recognized in the financial statements. [A ‘Provision’ is RECOGNIZED when it is probable that an outflow of resources will be required to settle the obligation, and the amount of the obligation can be estimated with reasonable accuracy. A ‘Contingent Liability’, on the other hand, is disclosed in the notes to the financial statements but is NOT RECOGNIZED in the financial statements.]

Another Difference is that a Provision is a CERTAIN liability, while a Contingent Liability is UNCERTAIN. A Provision is recognized when the amount of the liability can be estimated with reasonable accuracy, WHILE a Contingent Liability is a potential obligation that may or may not arise, and the amount of the obligation is uncertain.

The Bottom Line

The concept Difference between Provision and Contingent Liability STATES that A ´Provision´ is a certain liability that is RECOGNIZED in the financial statements when certain conditions are met, while a ´Contingent Liability´ is a potential liability that is DISCLOSED in the notes to the financial statements but is NOT recognized in the financial statements.

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