When must a company recognize a provision under IAS 37, and how is the provision measured?

IAS 37 draws a clear line between provisions that are recognized on the balance sheet and contingent liabilities that are only disclosed. The three recognition criteria must ALL be met simultaneously.

Recognition Criteria:

A provision is recognized when:

1. Present obligation — the entity has a present legal or constructive obligation as a result of a past event
2. Probable outflow — it is probable (more likely than not, i.e., >50%) that an outflow of economic benefits will be required to settle the obligation
3. Reliable estimate — a reliable estimate of the amount can be made

Your lawsuit example:

Sentinel Corp is defending a product liability claim. Legal counsel estimates a 60% probability of losing and paying $2 million.

• Present obligation? Yes — the alleged defective product was sold (past event).
• Probable outflow? Yes — 60% > 50% threshold under IFRS.
• Reliable estimate? Yes — $2 million is the estimated settlement.

All three criteria met = Recognize a provision of $2,000,000

Account	Debit	Credit
Litigation Expense (or Loss)	$2,000,000
Provision for Litigation		$2,000,000

Loading diagram...

IFRS vs US GAAP threshold:

This is critical for the exam:

Standard	"Probable" Means	Typical Threshold
IFRS (IAS 37)	More likely than not	>50%
US GAAP (ASC 450)	Likely to occur	~70-80%

So a 60% probability triggers a provision under IFRS but likely would NOT under US GAAP — it would only be disclosed as a contingent liability.

Measurement:

• Best estimate of the expenditure required to settle the obligation at the reporting date.
• For a large population of items (e.g., warranty claims), use the expected value (probability-weighted average).
• For a single obligation (like a lawsuit), use the most likely outcome.
• If the time value of money is material, the provision is measured at its present value, with the unwinding of the discount recognized as a finance cost.

Contingent liabilities (disclosed only):

If the probability is possible (not probable) — say 30-40% under IFRS — no provision is recognized. Instead, the company discloses the nature, estimated financial effect, and uncertainties in the footnotes.

Contingent assets:

These are NEVER recognized. If the inflow is probable, it is disclosed. If virtually certain, it is recognized as an asset (but then it is no longer "contingent").

Exam tip: When a question describes a possible future payment, immediately ask: (1) Is there a present obligation from a past event? (2) Is outflow probable? (3) Can I estimate it? If all three are yes, book the provision.

Explore more IAS 37 scenarios in our CFA Level I FRA question bank.