Provision (accounting)

In financial accounting, a provision is an account which records a present liability of an entity. The recording of the liability in the entity's balance sheet is matched to an appropriate expense account in the entity's income statement.

Sometimes in IFRS, but not in GAAP, the term reserve is used instead of provision. Such a use is, however, inconsistent with the terminology suggested by International Accounting Standards Board. The term "reserve" can be a confusing accounting term. In accounting, a reserve is always an account with a credit balance in the entity's Equity on the Balance Sheet, while to non-professionals it has the connotation of a pool of cash set aside to meet a future liability (a debit balance).

In the International Financial Reporting Standards (IFRS), the treatment of provisions (as well as contingent assets and liabilities) is found in IAS 37.

A provision can be a liability of uncertain timing or amount. A liability, in turn, is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.

A provision shall be recognized if the following criteria are fulfilled:

No provision, however, is recognized for costs that need to be incurred to operate in the future. Also, an obligation always involves another party to whom the obligation is owed (even if this party is unknown).

An executory contract is defined as a contract under which neither party has performed any of its obligations (e.g. delivering an object and paying for that object) or both parties have partially performed their obligations to an equal extent. In case of an executory contract, IAS 37 does not apply and neither an asset nor a liability is recorded. However, a provision needs to be recognized if the executory contract becomes onerous to the entity. An onerous contract is defined as a contract in which the unavoidable costs resulting from the entity meeting its contractual obligations exceed the economic benefits expected to be received under that contract.

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