Provisions and Contingent Liabilities (Ind AS 37)#
Businesses operate in a world of uncertainty. A company might be facing a massive patent infringement lawsuit, struggling with a disastrous loss-making contract, or offering 5-year warranties on a million laptops.
When do these uncertain future events cross the line from a vague fear to a hard liability that must be recorded on the balance sheet? Ind AS 37 provides the strict, threshold-based answers.
1. The Threshold for a "Provision"#
A provision is a liability of uncertain timing or amount. You know you owe money, but you aren't sure exactly when or how much.
Under Ind AS 37, a company must recognize a provision only if all three conditions are met:
- Present Obligation: The company has a present obligation as a result of a past event.
- Probable Outflow: It is probable (more likely than not) that an outflow of resources will be required.
- Reliable Estimate: A reliable estimate can be made of the amount.
2. Contingent Liabilities#
If the lawsuit lawyers advise: "It's a 50/50 case. We might win, we might lose." Because the outflow is not probable (>50%), the company cannot record a provision on the balance sheet. Instead, it is classified as a Contingent Liability and only disclosed in the Notes to Accounts.
3. Onerous Contracts#
Ind AS 37 includes a specific rule for "Onerous Contracts"—contracts where the unavoidable costs of meeting obligations exceed expected economic benefits. The moment a contract becomes onerous, the company must calculate the present value of future unavoidable losses and record that entire amount as a provision immediately on today's P&L.
