Uncertainty is the discriminator

Four outcomes for an uncertain obligation

A liability is a present obligation arising from a past event whose settlement is expected to cause an outflow of resources. Most liabilities are certain: Boreal Bikes owes its electricity supplier $4,200 for March, the bill just has not arrived, so it accrues the amount. There is no uncertainty about whether it owes or how much. An accrual is a liability that is simply unbilled.

A provision is a liability of uncertain timing or amount. Uncertainty is the whole difference. IAS 37 recognises a provision when three conditions are all met (¶14):

1. there is a present obligation (legal or constructive) as a result of a past event;
2. an outflow of resources is probable — under IAS 37 ¶23, more likely than not, which the course reads as more than 50 %; and
3. a reliable estimate can be made.

If the obligation exists but the outflow is not probable, or no reliable estimate can be made, the item is a contingent liability: it is disclosed in the notes, never recognised — unless the chance of an outflow is remote, in which case nothing is done at all. A possible obligation whose existence depends on a future event (an unresolved lawsuit where liability is genuinely open) is also a contingent liability.

Worked example — three lawsuits and a utility bill

Boreal Bikes is defending three claims at year-end:

• A cyclist injured by a frame failure. Counsel judges it 60 % likely Boreal will lose, with a best estimate of $150,000. Present obligation (the sale and the failure are past events), probable, estimable: a provision of $150,000 is recognised (the entry is in lesson 6.5).
• A supplier claiming breach of contract. Counsel puts the chance of loss at 30 %, damages if lost around $80,000. The outflow is possible but not probable: a contingent liability, disclosed in the notes with the nature of the claim and the estimate.
• A former employee’s claim that counsel calls baseless, perhaps a 5 % chance. Remote: nothing is recorded or disclosed.
• The March electricity bill. No uncertainty. An accrual — Dr Utilities Expense / Cr Accrued Liabilities — not a provision.

The tree

Present obligation from a past event?
  no  -> possible obligation? -> disclose unless remote
  yes -> outflow probable (> 50 %)?
           no  -> disclose as contingent liability, unless remote
           yes -> reliable estimate?
                    no  -> disclose
                    yes -> recognise a PROVISION

The thresholds the course uses are practice conventions, not numbers in the standard: probable is more than 50 %; remote is roughly 5–10 % or less; and virtually certain, the bar for a contingent asset, is roughly 95 % or more.

Contingent assets — the deliberate asymmetry

Boreal is also suing a component supplier and expects to win $60,000. A contingent asset is recognised only when its realisation is virtually certain; when it is merely probable it is disclosed. The asymmetry with liabilities is deliberate and is the conservatism of the framework at work: a probable loss goes on the balance sheet, a probable gain does not.

The US three-tier scale is not ours

US GAAP grades contingencies as probable / reasonably possible / remote. The middle tier is not an IFRS or ASPE category. Under IAS 37 the categories are probable (recognise), not probable but not remote (disclose), and remote (nothing).