Provision in Accounting as per IAS 37 represent a company’s estimated liabilities or obligations, which are RECOGNIZED in financial statements as an expense or loss.
Provisions are typically CREATED when there is uncertainty about the amount or timing of a liability, but the company has a legal or constructive obligation to settle that liability.
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Provision in Accounting – Types
There are VARIOUS types of provision in accounting as per IAS 37, including provisions for warranties, restructuring, bad debts, and contingencies. Each of these provisions serves a different purpose and is recognized differently in financial statements.
1. Provision for Warranties
Provision for Warranties is CREATED when a company sells a product and provides a warranty to the customer. The provision represents the company’s estimate of the cost of providing warranty service to the customer, based on historical data or other factors. The provision is RECOGNIZED as an expense in the income statement, reducing the company’s profit for the period.
2. Provision for Restructuring
Provision for Restructuring is CREATED when a company decides to restructure its operations, such as closing a plant or laying off employees. The provision represents the estimated cost of the restructuring, including employee severance payments, lease termination costs, and other related expenses. The provision is RECOGNIZED as an expense in the income statement, reducing the company’s profit for the period.
3. Provision for Doubtful Debts
Provision for Doubtful Debts is CREATED when a company has outstanding accounts receivable that are unlikely to be collected. The provision represents the estimated amount of bad debt that the company will incur, based on historical data or other factors. The provision is RECOGNIZED as an expense in the income statement, reducing the company’s profit for the period.
4. Contingencies
Contingencies are CREATED when a company has a potential liability that is uncertain or contingent on future events. The provision represents the estimated amount of the liability, based on the likelihood of the event occurring and the best estimate of the potential amount. Contingencies are DISCLOSED in the financial statements, and the provision is RECOGNIZED as an expense if and when the liability becomes probable and can be reasonably estimated.
Provision in Accounting – Is It an Asset or Liability?
It is an important concept because it ensure that financial statements accurately reflect a company’s financial position and performance. By RECOGNIZING ‘potential liabilities‘ as expenses, provisions reduce the company’s reported profit and ensure that the company has adequate reserves to meet its obligations.
However, CREATING provisions requires judgment and estimation, which can be subjective and can vary from company to company. As a result, there is often a degree of uncertainty associated with provisions, and companies must DISCLOSE the assumptions and estimates used in their calculations.
The Bottom Line
Provision in Accounting as per International Accounting Standard (IAS 37) is a CRITICAL concept, representing a company’s estimated liabilities or obligations. They are RECOGNIZED in financial statements as an expense or loss and are used to ensure that financial statements accurately reflect a company’s financial position and performance. Different types of provisions exist, including provisions for warranties, restructuring, bad debts, and contingencies, each serve a unique purpose.
While provisions require judgment and estimation, they are essential in providing stakeholders with an accurate picture of a company’s financial health.
Chartered Accountant – ICAP
Bachelor of Accounting (Honours) – AeU, Malaysia