Ind AS 37 splits a possible future obligation into three categories based on probability, with each carrying a completely different accounting outcome. A provision is recognised on the balance sheet when an obligation exists, it's PROBABLE that an outflow of resources will be required to settle it, and the amount can be reliably estimated. A contingent liability — where the obligation's existence is uncertain, or an outflow is only POSSIBLE rather than probable, or the amount can't be reliably estimated — is disclosed in the notes but not recognised. Where the outflow is REMOTE, nothing is required at all — neither recognition nor disclosure.
The three-way test
| Likelihood of outflow | Treatment |
|---|---|
| Probable (generally understood as more likely than not) | Recognise a provision, if the amount can be reliably estimated |
| Possible, but not probable | Disclose as a contingent liability — no recognition |
| Remote | No disclosure, no recognition required |
Common practice, not a requirement
Legal counsel's own assessment of litigation outcomes is usually the single most important input to this classification — which is exactly why SA 501's requirement to communicate directly with external legal counsel, rather than relying on management's characterisation alone, matters so much for this specific balance.
Why contingent assets are treated far more conservatively
A contingent asset — a possible future inflow, such as an insurance claim or a favourable litigation outcome not yet certain — is NEVER recognised while still contingent, even where the inflow is probable. It's only disclosed where an inflow is probable, and recognised on the balance sheet only once it becomes virtually certain, a deliberately higher bar than the "probable" threshold used for liabilities. The asymmetry is intentional: Ind AS 37 is built to avoid overstating assets on the basis of optimistic uncertain outcomes, while still requiring provisions for probable obligations even before they're certain.
What drives the amount of a provision once recognised
- 01Best estimate of the expenditure required to settle the obligationUsing the most likely outcome for a single obligation, or an expected-value calculation across a range of possible outcomes where a large population of similar obligations exists (such as warranty claims).
- 02Discounting, where the time value of money is materialA provision expected to be settled well into the future should be discounted to present value, using a pre-tax rate reflecting current market assessments of the time value of money and the risks specific to the liability.
- 03Reviewing at each reporting dateA provision has to be reassessed and adjusted to reflect the current best estimate — it's not simply carried forward unchanged from the period it was first recognised.
A provision set once and never revisited, even as new information (a settlement offer, a changed legal opinion, an actual payment) comes in, is itself a misstatement risk under Ind AS 37's reassessment requirement — the number needs active management at every reporting date, not a one-time estimate carried forward by habit.
This is practical guidance written for audit teams, not an authoritative statement of any standard or statute. Standards, forms and timelines change. Check the current text issued by the ICAI and the relevant authority before relying on anything here in an audit file.
Related resources
- Bank, cash & treasuryThe bank guarantee nobody had disclosed as a contingent liabilityThe bank's confirmation letter listed a guarantee outstanding. The client's draft notes to accounts didn't mention it at all.
- Audit documentationInd AS 12: income taxes, and how a deferred tax balance actually gets builtDeferred tax isn't computed from the profit and loss difference between book and tax. It's computed balance sheet item by balance sheet item, and that distinction changes the whole calculation.
- Inventory & stockSA 501: physical inventory attendance and litigation inquiry, specificallySA 501 exists because two specific kinds of evidence don't behave like ordinary evidence: a physical count that happens once a year, and a legal exposure management has every incentive to understate.
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