Provision (Accounting)

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In accounting, provision means a liability of uncertain timing or amount. This is an official definition of International Accounting Standards Board, quoted from IAS 37.

The need to record provisions arises from accrual basis accounting and also from an accounting principle of prudence. IAS 37 requires that all liabilities which are probable (i.e. with probability of occurring over 50%) are recorded in a balance sheet. Local GAAPs have different requirements.

Sometimes, a word reserve is used in the same meaning as provision. However, such use is not consistent with IFRS terminology. IFRS use the term reserve differently - see the link to Reserve (Accounting).

Some provisions are not presented on a liability side of the balance sheet. Instead, they are shown as negative assets, decreasing value of other assets of the company. They are mostly used when a book value of assets is higher than their fair value, so the asset value shown in books is not realistic.

[edit] Examples of provisions

Provisions presented as liabilities:

• Provision for reorganisation / severance provision - this provision is recorded when a company announces a plan to change its organisation structure, which will incur significant costs, including termination of personnel

• Litigation provision - represents expected or most probable result of a legal case against the company

• Environmental provisions - recorded by enterprises which will incurr significant costs for cleaning the environment, due to pollution resulting from current activities

• Dismantling / recultivation provisions - recorded when a company knows that after end of current activities, they will be obliged to incur significant costs to e.g. dismantle buildings, clean the site, safely close exhausted mines, get rid of dangerous materials etc.

• Provision for employee (or post-employment) benefits - when a benefit system of the company comprises benefits for employees leaving the company, or even employees that already left the company, or the company has significant benefits based on length of service, they need to accrue the liabilities over the time of employment of each employee

Provisions presented as negative assets:

• Bad debt provision - provision decreasing the value of receivables, because their recoverability is doubtful. Mostly recorded based on aging of the receivables, older receivables are more doubtful that new ones.

• Provision for product returns / credit note provision - provision decreasing the value of receivables due to expected sales returns. Normally recorded based on historical experience as a percentage of recent sales.

• Market valuation provision - also called market valuation reserve, is used to decrease a value of inventory, when its market price is lower than its current book (accounting) value

• Provision for excessive, obsolete or damaged inventory - decreasing the value of inventory with uncertain marketability (due to its obsoletness, damages or excessive volume on stock)

• Impairment provisions - generally any provisions recorded when a book value of an asset is significantly higher than its fair value