Provision definition
/What is a Provision?
A provision is the amount of an expense that an entity elects to recognize now, before it has precise information about the exact amount of the expense. For example, an entity routinely records provisions for bad debts, sales allowances, and inventory obsolescence.
Characteristics of a Provision
The key characteristics of a provision are as follows:
Present obligation. An organization has a legal or constructive obligation as a result of past events. This obligation may arise from contracts, legislation, or company practices.
Uncertainty. The timing or amount of the obligation is uncertain.
Probable outflow of resources. It is more likely than not (i.e., >50% probability) that an outflow of resources (cash or other assets) will be required to settle the obligation.
Reliable estimation. The amount of the obligation can be estimated reliably. If the amount cannot be reasonably estimated, the obligation is disclosed as a contingent liability instead of a provision.
Recognition in financial statements. Provisions are recorded as liabilities in the balance sheet. The corresponding expense is recognized in the income statement
Accounting for a Provision
A provision should be recognized as an expense when the occurrence of the related obligation is probable, and you can reasonably estimate the amount of the expense. The relevant expense account is then debited, while an offsetting liability account is credited.
Presentation of a Provision
A provision is recorded in a liability account, which is typically classified on the balance sheet as a current liability. The accounting staff should regularly review the status of all recognized provisions, to see if they should be adjusted.
Example of a Provision
The accountant for Arbuthnot Enterprises reviews the latest report of the inventory oversight committee, and notes that they have identified $30,000 of inventory that is likely to be obsolete. She notes that the company’s existing provision for obsolete inventory is only $10,000, so she increases the provision by $20,000 to match the amount reported by the committee. This results in a $20,000 increase in the cost of goods sold in the current reporting period.