Under Ind AS 37, a provision and a contingent liability can arise from the same uncertain event, but they are not accounted for in the same way. A provision is recognised in the financial statements when the recognition conditions are met. A contingent liability is generally not recognised; instead, it is disclosed unless the possibility of an outflow is remote. The distinction matters because getting it wrong can overstate or understate liabilities and profit.
ICAI's Educational Material on Ind AS 37 explains the recognition, measurement and disclosure framework for provisions, contingent liabilities and contingent assets. ICAI's 2025-26 Compendium of Indian Accounting Standards also includes Ind AS 37 in the current standards collection.
What is a provision?
A provision is a liability of uncertain timing or amount. Ind AS 37 requires recognition when three conditions are satisfied: the entity has a present legal or constructive obligation from a past event; an outflow of resources embodying economic benefits is probable; and a reliable estimate can be made.
The uncertainty does not prevent recognition. In fact, uncertainty is part of what distinguishes a provision from an ordinary payable. A trade payable may have a known invoice amount and payment date, while a warranty provision may depend on how many products fail and what repairs ultimately cost.
What is a contingent liability?
A contingent liability commonly arises in either of two situations. First, there may be a possible obligation whose existence will be confirmed only by uncertain future events not wholly within the entity's control. Second, there may be a present obligation from a past event that is not recognised because an outflow is not probable or the amount cannot be measured with sufficient reliability.
Unlike a provision, a contingent liability is not normally recognised as a liability in the balance sheet. It is disclosed in the notes unless the possibility of an outflow of resources is remote. The disclosure normally explains the nature of the contingency and, where practicable, gives an estimate of its financial effect and relevant uncertainties.
The practical decision framework
- Identify the past event: determine what has already happened by the reporting date. Future intentions alone do not normally create a present obligation.
- Ask whether a present obligation exists: consider both legal obligations and constructive obligations created by an entity's established conduct, published policies or sufficiently specific statements.
- Assess probability of outflow: if an outflow is probable and the other recognition conditions are met, recognise a provision. If an obligation is possible, or a present obligation exists but outflow is not probable, consider contingent-liability disclosure.
- Test whether a reliable estimate can be made: Ind AS 37 notes that reliable estimation should be possible except in extremely rare cases. If reliable measurement is genuinely unavailable, recognition may not be appropriate and disclosure becomes important.
- Reassess at every reporting date: probability and measurement can change as litigation, negotiations, technical evidence or other facts develop.
Worked example: customer warranty
Assume a manufacturer sells products with a one-year warranty and past experience shows that some products will require repairs. Sales made before year-end create the relevant past event, and the warranty terms create a present obligation. If an outflow for the portfolio of warranty obligations is probable and repair costs can be reliably estimated, the entity recognises a provision rather than merely mentioning a contingency in the notes.
The amount should represent the best estimate of expenditure required to settle the present obligation at the reporting date. For a large population of similar warranty claims, probability-weighted expected outcomes can be more appropriate than selecting only the single most likely claim amount.
Worked example: lawsuit
Assume a company is defending a lawsuit at year-end. Its lawyers conclude that a present obligation is possible but that it is not probable that the company will have to make a payment. On those facts, recognition of a provision would generally be inappropriate. A contingent-liability disclosure may instead be required unless the possibility of outflow is remote.
If new evidence later makes an adverse settlement probable and the amount can be reliably estimated, the accounting can change from disclosure of a contingency to recognition of a provision. The classification is therefore based on evidence at the reporting date, not on the label originally assigned to the matter.
How is a provision measured?
Ind AS 37 uses the best estimate of the expenditure required to settle the present obligation or transfer it to a third party at the reporting date. Risks and uncertainties should be reflected without deliberately creating excessive provisions. Where the time value of money is material, the provision is measured at present value using an appropriate pre-tax discount rate reflecting current market assessments of time value and liability-specific risks not already reflected in cash flows.
Provisions are reviewed at each reporting date and adjusted to the current best estimate. If an outflow is no longer probable, the provision is reversed. A provision should also be used only for expenditures for which it was originally recognised; using an unrelated provision to absorb another expense distorts performance.
What about contingent assets?
Ind AS 37 applies a deliberately cautious approach to uncertain gains. A contingent asset is not recognised. It is disclosed when an inflow of economic benefits is probable. When realisation becomes virtually certain, the related asset is no longer contingent and recognition becomes appropriate. This prevents uncertain gains from being recorded too early.
Year-end documentation checklist
- Legal matters: obtain an updated litigation list and, where necessary, external legal assessment.
- Contracts and warranties: identify obligations arising from warranties, guarantees, onerous contracts and customer commitments.
- Constructive obligations: review public announcements, established practices and communications that may have created valid expectations.
- Probability assessment: document why an outflow is probable, possible or remote using evidence available at the reporting date.
- Measurement: retain the assumptions, ranges, probability weights, discount rates and supporting calculations used for recognised provisions.
- Disclosures: reconcile provision movements and contingent-liability notes with legal, tax and operational registers.
- Subsequent events: review post-balance-sheet developments for evidence about conditions existing at the reporting date.
Common mistakes to avoid
- Calling every uncertain liability a provision without testing whether a present obligation exists.
- Refusing to recognise a liability merely because the final amount is uncertain.
- Recognising a provision for future operating losses when no present obligation exists.
- Failing to disclose a possible obligation simply because it is not recognised on the balance sheet.
- Keeping an old provision unchanged even after probability or expected settlement cost has materially changed.
- Recognising a contingent asset too early because management expects a favourable outcome.
Practical takeaway
The core Ind AS 37 question is not whether an item is uncertain; both provisions and contingencies involve uncertainty. The real test is whether a present obligation exists, whether an outflow is probable and whether the amount can be reliably estimated. Recognise a provision when those conditions are met, disclose a contingent liability when recognition is not justified but disclosure is required, and reassess the conclusion at every reporting date using current evidence.
