Ind AS 37 separates uncertain obligations into provisions and contingent liabilities. A provision is recorded in the financial statements when the recognition tests are met. A contingent liability is not recorded as a liability; it is disclosed unless the chance of an outflow is remote.
The label used by management or a lawyer does not decide the accounting. The decision depends on the facts at the reporting date: Is there a present obligation from a past event? Is an outflow probable? Can the amount be estimated reliably? ICAI's current 2025–26 Ind AS 37 text sets out these recognition, measurement and disclosure rules.
Provision and contingent liability: the quick decision table
| Reporting-date assessment | Accounting treatment | Why |
|---|---|---|
| Present legal or constructive obligation; outflow probable; reliable estimate available | Recognise a provision | All three recognition conditions are met. |
| Possible obligation, or present obligation but outflow is not probable | Disclose a contingent liability | Recognition is not justified, but readers need the uncertainty unless the outflow is remote. |
| Present obligation but no reliable estimate can be made | Disclose a contingent liability | Ind AS 37 says this should occur only in extremely rare cases. |
| Possibility of outflow is remote | Normally no contingent-liability disclosure | The standard provides a disclosure exemption for remote outflows. |
What is a provision?
A provision is a liability whose timing or amount is uncertain. It is different from an ordinary trade payable. A supplier invoice may have a known amount and payment date, while a warranty provision depends on how many products fail and what the repairs will cost.
Recognise a provision only when all three conditions are present:
- The entity has a present legal or constructive obligation because of a past event.
- An outflow of resources embodying economic benefits is probable.
- A reliable estimate can be made.
For Ind AS 37, “probable” means that an outflow is more likely than not. Uncertainty about the final amount does not by itself prevent recognition. Estimates are a normal part of financial reporting, and Ind AS 37 says failure to make a reliable estimate should be extremely rare.
Legal and constructive obligations
A legal obligation can arise from a contract, legislation or another operation of law. A constructive obligation arises from the entity's conduct—for example, an established practice, a published policy or a sufficiently specific statement that creates a valid expectation in other parties.
A management intention is not enough. The past event must leave the entity with no realistic alternative to settling the obligation. Future operating costs do not create a provision merely because management expects to incur them. Financial statements report obligations that exist at the reporting date, not costs that may arise only from future actions.
What is a contingent liability?
A contingent liability can be a possible obligation whose existence depends on uncertain future events outside the entity's full control. It can also be a present obligation that is not recognised because an outflow is not probable or, in extremely rare circumstances, the amount cannot be measured reliably.
A contingent liability is not recognised in the balance sheet. It is disclosed in the notes unless the chance of outflow is remote. The note normally describes the nature of the matter and, where practicable, the estimated financial effect, key uncertainties and possible reimbursement.
The assessment must be updated. If new evidence makes an outflow probable and a reliable estimate is available, an item previously disclosed as contingent may become a recognised provision.
Worked example: expected-value warranty provision
Assume a manufacturer has sold goods with an assurance warranty. Based on current evidence, 75% of the products are expected to have no defects, 20% could have minor defects and 5% could have major defects. If every product had a minor defect, repairs would cost ₹10 lakh. If every product had a major defect, repairs would cost ₹40 lakh.
| Outcome | Probability | Cost if outcome applied to all products | Weighted amount |
|---|---|---|---|
| No defects | 75% | ₹0 | ₹0 |
| Minor defects | 20% | ₹10 lakh | ₹2 lakh |
| Major defects | 5% | ₹40 lakh | ₹2 lakh |
| Expected provision | ₹4 lakh | ||
The calculation is (75% × ₹0) + (20% × ₹10 lakh) + (5% × ₹40 lakh) = ₹4 lakh. For a large population of similar obligations, Ind AS 37 uses probability-weighted outcomes to arrive at the expected value. The probability of a claim on one product may be small, but the class of warranty obligations as a whole can still make an outflow probable.
Before using this model, confirm that the warranty is an assurance obligation. A warranty that provides an additional service may fall under Ind AS 115 instead. Our warranty accounting guide explains that separate classification question.
Worked example: a lawsuit
Assume a company is defending a lawsuit at year-end. After considering legal advice and other evidence, management concludes that a present obligation may exist but payment is not more likely than not. A provision is not recognised on those facts. A contingent-liability disclosure is considered unless the chance of payment is remote.
If later evidence makes it more likely than not that a present obligation exists and an outflow will be required, the accounting may change to a provision. For the audit procedures used to identify and test litigation matters, see the related SA 501 litigation and claims checklist.
How to measure a provision
The provision is the best estimate of the expenditure required to settle the present obligation at the reporting date. For a large population of similar items, expected value may be the best method. For a single obligation, the most likely outcome can be a starting point, but other possible outcomes must also be considered when they could materially change the estimate.
Risks and uncertainties should be reflected carefully. They do not justify an excessive provision. If the time value of money is material, measure the provision at present value using a pre-tax discount rate that reflects current market assessments and liability-specific risks not already included in the cash-flow estimate.
Review provisions at every reporting date. Adjust them to the current best estimate and reverse a provision if an outflow is no longer probable. Use a provision only for the expenditure for which it was originally recognised.
Contingent assets
A contingent asset is not recognised because doing so could record income that may never be realised. Disclose it when an inflow of economic benefits is probable. When the inflow becomes virtually certain, the asset is no longer contingent and recognition becomes appropriate. Reassess contingent assets as facts change.
Year-end review checklist
- Build the population: reconcile legal cases, warranties, guarantees, onerous contracts, tax disputes, environmental duties and other potential obligations.
- Find the past event: identify what happened before the reporting date and why it may create an obligation.
- Test the obligation: document whether it is legal, constructive, possible or absent.
- Assess probability: support probable, possible or remote conclusions with reporting-date evidence.
- Measure recognised items: retain outcome ranges, probability weights, cost assumptions and discount calculations.
- Check presentation and notes: reconcile provision movements and contingent disclosures to the underlying registers.
- Review later evidence: consider events after the reporting period that provide evidence about conditions existing at year-end.
- Approve and archive: record who prepared and reviewed each conclusion and retain the supporting documents.
Common mistakes
- Recording a provision for planned future spending when no present obligation exists.
- Calling every uncertain item a contingency even when the recognition tests are met.
- Refusing to recognise a provision merely because the final amount is uncertain.
- Using one unsupported percentage for years without updating claims or cost data.
- Leaving an old provision unchanged after the probability or expected settlement cost changes.
- Recognising a contingent asset before the inflow becomes virtually certain.
The practical rule is simple: identify the obligation first, then assess probability and measurement. Recognise a provision only when all three tests are met, disclose a contingent liability when recognition is not justified but disclosure is required, and update the conclusion at every reporting date.
