This standard distinguishes between provisions and contingent liabilities. A provision is included in the statement of financial position at the best estimate of the expenditure required to settle the obligation at the end of the reporting period.
A contingent liability is not recognised in the statement of financial position. However, unless the possibility of an outflow of economic resources is remote, a contingent liability is disclosed in the notes.
A provision is a liability of uncertain timing or amount. A liability may be a legal obligation or a constructive obligation. A constructive obligation arises from the entity’s actions, through which it has indicated to others that it will accept certain responsibilities, and as a result has created an expectation that it will discharge those responsibilities. Examples of provisions may include warranty obligations; legal or constructive obligations to clean up contaminated land or restore facilities; and a retailer’s policy to refund customers.
A provision is measured at the amount that the entity would rationally pay to settle the obligation at the end of the reporting period or to transfer it to a third party at that time. Risks and uncertainties are taken into account in the measurement of a provision. A provision is discounted to its present value.
FRS 37 elaborates on the application of the recognition and measurement requirements for three specific cases:
• Future operating losses – A provision cannot be recognised because there is no obligation at the end of the reporting period.
• An onerous contract gives rise to a provision.
• A provision for restructuring costs is recognised only when the entity has a constructive obligation – the main features of the detailed restructuring plan have been announced to those affected by it.