IAS 37: provisions, contingent liabilities and contingent assets

A customer sues for ₦250 million. A factory is to close. A clean-up is required by law. A supplier contract has turned into a loss-maker. In each case a company must decide: put a liability in the statements, mention it only in the notes, or say nothing.

International Accounting Standard (IAS) 37, Provisions, Contingent Liabilities and Contingent Assets, gives a clear set of tests so that companies cannot hide real obligations, and cannot create “cookie jar” provisions to smooth profit.

This topic covers the definitions, the three recognition tests, measurement, the use of provisions, onerous contracts (including leases), future operating losses, restructuring, future repairs, contingent liabilities and assets, and the judgements. The previous topics covered non-current assets. The next topics cover impairment. May 2026 Question 7 tested litigation and an onerous lease, each for 5 marks.

Key terms in plain English

Syllabus check

IAS 37 is examinable at this level. This topic covers:

• B3(a) and (b) how the timing and measurement of non-financial liabilities affect the statements, and appraising the treatment of provisions, contingent liabilities and contingent assets under IAS 37 and leases under IFRS 16;
• D2(f) and the earlier topic on creative accounting, since provisions are a classic tool of big bath accounting.

CAMA 2020 and provisions

The Companies and Allied Matters Act 2020 (CAMA 2020) sets the statements and the duty to tell the truth about liabilities.

Recognition

A provision is recognised when all three apply:

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

If any test fails, no provision is recognised. A provision differs from other liabilities because the timing or amount is uncertain.

Measurement

• Best estimate at the end of the reporting period: the amount the entity would rationally pay to settle or transfer the obligation.
• For a large population of items (such as warranties) use expected value. For a single obligation the most likely outcome is often the best estimate.
• Take account of risks and uncertainties, and of future events where there is sufficient objective evidence.
• If the time value of money is material, use the present value at a pre-tax rate that reflects current market assessments and risks specific to the liability. The unwinding of the discount is a finance cost.
• A reimbursement (for example, insurance) is recognised as a separate asset only when it is virtually certain, at no more than the provision. Do not net it off.
• Review each provision at every reporting date. Use it only for the expenditure it was set up for. If it is too large, release the excess to profit. If it is too small, charge the extra.

Specific situations

Onerous contracts

If the unavoidable costs of meeting a contract exceed the benefits expected, recognise a provision for the present obligation under the contract. The unavoidable cost is the lower of the cost of fulfilling it and any compensation or penalty for not fulfilling it.

Leases. For a lease that has already started, a lessee applying IFRS 16 does not use an onerous contract provision. The lease liability is already on the statement of financial position, and if the premises have no further use and cannot be sub-let, the right-of-use asset is tested for impairment under IAS 36. IAS 37 still applies to leases that have not started and to short-term and low-value leases that are expensed.

Future operating losses

No provision. They come from future events, not a past event.

Restructuring

A provision is recognised only if there is a present obligation: the entity has a detailed formal plan and has raised a valid expectation in those affected by starting to implement it or announcing its main features. The provision covers only direct expenditure arising from the restructuring, not costs of retraining or relocating continuing staff or future operating losses.

Future repairs and major overhauls

No provision for future repairs or replacement parts unless there is an obligation. The entity could avoid the cost by its future actions. Capitalise replacement of a part under IAS 16 and expense routine repairs.

Decommissioning

An obligation to dismantle and restore a site is recognised as a provision, and the cost is added to the asset (IAS 16). The discount unwinds each year.

Contingent liabilities and contingent assets

A contingent liability is (a) a possible obligation from past events, whose existence depends on uncertain future events not wholly in the entity’s control, or (b) a present obligation that is not recognised because an outflow is not probable or the amount cannot be measured reliably. It is disclosed unless the possibility of outflow is remote.

A contingent asset is a possible asset whose existence depends on uncertain future events. It is never recognised. It is disclosed if an inflow is probable. If an inflow is virtually certain, it is no longer contingent and the asset is recognised.

Reassess at each reporting date: provisions may be settled, contingencies may firm up, and items may become remote and drop out.

Areas of judgement

• Whether a present obligation exists.
• Whether an outflow is probable.
• Whether a reliable estimate can be made.
• Whether the restructuring tests are met.
• Whether a loss is a future operating loss or an onerous contract.
• How to measure the provision.

The rules in more depth

Why “past event” matters

Before IAS 37, companies provided for things they merely intended to do, making provisions in good years and releasing them in bad years. A past event test stops that: the obligation must exist at the reporting date regardless of what the company does next.

Why disclosure is the middle step

If a matter is possible but not probable, recognising it would overstate liabilities, and ignoring it would hide a risk. Disclosure tells the reader without recording a number.

Why a contingent asset is treated harder than a contingent liability

Recognising a gain that may never arrive would overstate profit. This is the prudence principle at work.

Why uncertainty about the amount is not a reason to leave out a provision

If an obligation exists and an outflow is probable, a range of outcomes still allows a best estimate. Only in very rare cases can no reliable estimate be made, and then it is a contingent liability.

Worked examples

1. A large population of similar items, so use expected value.
2. Expected cost.
   (75% × nil) + (20% × ₦1m) + (5% × ₦4m) = ₦0.4 million.
3. Provide ₦0.4 million.

1. Present obligation from a past event: possible, not yet established.
2. On the facts, an outflow is possible but not probable, so no provision.
3. Disclose a contingent liability: the nature of the claim, the ₦250 million, and the uncertainties.
4. If legal advice says the loss is probable, recognise the best estimate as a provision. If remote, no disclosure.

1. The contract is onerous: costs exceed benefits.
2. Cost of fulfilling the contract.
   ₦11m − ₦8m = ₦3m net loss.
   Cost of exit = ₦5m.
   Take the lower.
3. Provision = ₦3 million.

1. A detailed formal plan exists and a valid expectation has been raised by the announcement before the year end.
2. Provision for direct costs = ₦40 million. Retraining of continuing staff and future operating losses are excluded.
3. If the board had only approved the plan and not announced or started it, there would be no obligation and no provision.

1. The lease started in 2020, so IFRS 16 applies. The ₦22.5m is already recognised as the lease liability and is not provided for again.
2. With no further use or sub-let, the recoverable amount of the right-of-use asset is nil, so there is an impairment loss of ₦20 million in profit or loss (IAS 36).
3. The liability stays and is paid in future, with interest accruing.

Note: the Pathfinder solution is slightly different from ours here. The suggested solution to May 2026 Question 7(b) calls the lease an onerous contract and provides for the full ₦22.5 million, debiting profit or loss and crediting a provision. IFRS 16 itself reflects such a lease by impairing the right-of-use asset, because the lease liability is already recognised, so we follow the standard.

In the exam, set out the IFRS 16 treatment, and then say that if the question treats it as an onerous contract the loss equals the unavoidable cost, here ₦22.5 million.

How to score full marks

• Apply the three tests in order and state the answer to each. If one fails, stop and say what follows (contingent liability, disclosure, nothing).
• Use the likelihood table for liabilities and assets.
• For measurement, pick expected value or most likely outcome, and discount if material.
• For restructuring, check formal plan and valid expectation, and list only direct costs.
• For leases, check whether IFRS 16 applies before talking about onerous contracts.
• Link to creative accounting where the question hints at a new manager making large provisions.

Common mistakes in the exam

• Providing for a claim that is only possible.
• Leaving out a provision because the amount is uncertain.
• Providing for future operating losses or for future repairs.
• Providing for a restructuring that is approved but not announced.
• Netting an insurance recovery against the provision, or recognising it before it is virtually certain.
• Recognising a contingent asset.
• Forgetting to discount a long-term provision and unwind the discount.
• Providing again for a lease liability already recognised under IFRS 16.

Quick revision

• Provision tests: present obligation (legal or constructive) from a past event, probable outflow, reliable estimate.
• Measure: best estimate, expected value for populations, present value if material, reimbursement only if virtually certain and shown separately.
• Onerous contract: lower of cost to fulfil and cost to exit. Leases started: impair the right-of-use asset.
• No provision for future operating losses or avoidable future repairs.
• Restructuring: formal plan plus valid expectation. Direct costs only.
• Contingent liability: disclose unless remote. Contingent asset: disclose only if probable.
• CAMA 2020: ss. 374(1), 377(1), 378, 404(7), 406.

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer. Full model answers follow the written questions.

Recall check: multiple choice

The real ICAN paper has no multiple-choice section. These questions are for quick recall. The written questions that follow are closer to the exam.

Written questions

Model answers

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