What is a Provision?
Definition: A provision is an amount set aside for the probable, but uncertain, economic obligations of an enterprise.
A provision is an amount that you put in aside in your accounts to cover a future liability.
The purpose of a provision is to make a current year’s balance more accurate, as there may be costs which could, to some extent, be accounted for in either the current or previous financial year. These costs that distinctly belong to a specific year could be misleading if accounted for in the future.
A provision is not a form of saving, even though it is an amount that is put aside for a future plausible cost or obligation. Provisions resulting impact is a reduction in the company's equity.
When accounting, provisions are recognized on the balance sheet and then expensed on the income statement.
When can a provision be set aside?
There are several factors which can prompt provisions for liabilities. Certain criteria must be fulfilled before one may treat an obligation as a provision.
These criterions are:
- That an obligation must have been determined to be probable, but not certain. It must be estimated to have a probability of occurring of more than 50%.
- The obligation must be a result of events that will advance the balance sheet date, and could result in a legal or constructive obligation.
- That it must be probable that obligation results in a financial drag on economic resources.
- That the company must perform a reliable amount of regulatory measurement of that obligation. The measurement must be made by company management.
What could a provision be?
Some examples of provisions are:
- Guarantees
- Losses
- Deferred tax
- Restructuring Liabilities
- Pension
- Severance costs
Provision: an expense or liability
In the United States Generally Accepted Accounting Principles (GAAP), a provision means an expense. On the other hand, in the International Financial Reporting Standards (IFRS), a provision means a liability.
So, in the United States, a provision made for for income taxes is the same
as an income tax expense, while internationally, a provision for income taxes means a liability for income taxes payable.
