## Learning Outcomes

After reading this article, you should be able to explain the definition and recognition of provisions, distinguish provisions from contingent liabilities and contingent assets, account for onerous contracts, and describe the principles for recognising and measuring government grants under international accounting standards. You will also be able to apply these concepts to practical ACCA exam questions involving estimation, disclosure, and specific industry scenarios.

## ACCA Strategic Business Reporting (SBR) Syllabus

For ACCA Strategic Business Reporting (SBR), you are required to understand the recognition, measurement, and disclosure of provisions, contingent liabilities, and government grants, including application to special cases such as onerous contracts and restructuring provisions. Revision on the following syllabus areas is recommended:

- The recognition, measurement, and derecognition of provisions and contingent liabilities under IAS 37
- Differentiation of provisions, contingent liabilities, and contingent assets
- Principles and accounting treatment for onerous contracts
- Reporting and disclosure requirements for government grants and assistance under IAS 20 and IAS 41
- Accounting for environmental and restructuring provisions
- Judgement and estimation involved in assessing legal obligations and probabilities

## Test Your Knowledge

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, look more closely at that area during your revision._

1. State the three criteria for recognising a provision under IAS 37.
2. Define a contingent liability and explain how it differs from a provision.
3. An entity enters into an unavoidable contract to supply goods at a loss. What is the required accounting treatment?
4. When should a government grant be recognised according to IAS 20?

## Introduction

Provisions, contingent liabilities, onerous contracts, and government grants are important areas in financial reporting and carry substantial marks in the ACCA Strategic Business Reporting (SBR) exam. Correctly distinguishing between these concepts is essential for clear and faithful representation of obligations and assistance. As reporting often involves uncertain outcomes, a disciplined approach based on international accounting standards is required.

> **Key Term: provision**
> A liability of uncertain timing or amount, recognised when an entity has a present obligation from a past event, it is probable an outflow of resources will be needed to settle it, and a reliable estimate can be made.

### Recognition and Measurement of Provisions

A provision is recognised only when all of the following conditions are met:

1. There is a present obligation (legal or constructive) from a past event;
2. It is probable that an outflow of economic resources will be required to settle the obligation;
3. The amount can be estimated reliably.

> **Key Term: present obligation**
> An obligation that the entity has no realistic alternative but to settle, arising from past events.

### Estimating Provisions

The amount recognised as a provision should be the best estimate of the expenditure required at the reporting date. Where the effect of time value of money is material, the provision should be discounted to present value.

### Worked Example 1.1

An electronics retailer sells 1,000 appliances with an included one-year warranty. Past experience indicates 5% will need repairs at an average cost of \$200 per appliance. What provision should be recognised?

> **Answer:**
> 1,000 × 5% × \$200 = \$10,000.
> A warranty provision of \$10,000 is recognised in the statement of financial position and charged to profit or loss.
>
> **Exam Warning:**
> Provisions should not be made for future operating losses, as these do not result from past events creating present obligations.

### Derecognition and Review

Provisions are reviewed at each reporting date and adjusted to reflect current best estimates. If an obligation is no longer probable or cannot be estimated reliably, the provision is reversed.

### Contingent Liabilities and Contingent Assets

> **Key Term: contingent liability**
> A possible obligation from past events which will be confirmed only by uncertain future events not wholly within the control of the entity, or a present obligation that is not recognised because it is not probable or cannot be estimated reliably.
> **Key Term: contingent asset**
> A possible asset arising from past events whose existence will be confirmed only by the occurrence of uncertain future events not wholly within the control of the entity.

Contingent liabilities are _not_ recognised in the financial statements but are disclosed unless the chance of an outflow is remote. Contingent assets are similarly not recognised but may be disclosed if an inflow is probable.

### Onerous Contracts

An onerous contract is one in which the unavoidable costs of meeting the contract exceed the expected economic benefits.

> **Key Term: onerous contract**
> A contract where the cost of fulfilling the obligation exceeds the benefits to be obtained under it.

IAS 37 requires that the present obligation under an onerous contract is recognised as a provision, measured at the lower of the cost of fulfilling the contract or the cost to exit the contract.

### Worked Example 1.2

A company is bound by a non-cancellable contract to buy equipment for \$50,000. Due to market changes, the equipment's recoverable value is now only \$30,000. Penalty for contract cancellation is \$17,000.

How should the contract be treated?

> **Answer:**
> The contract is onerous because the cost to fulfil (\$50,000) exceeds the benefit (\$30,000). Provision = lower of loss on fulfilment (\$20,000) or penalty to exit (\$17,000):
> **Provision = \$17,000**.
>
> **Revision Tip:**
> Always compare the cost to fulfil with the cost to terminate when deciding the amount to recognise for an onerous contract.

### Environmental and Restructuring Provisions

Provisions may also be needed for legal or constructive obligations to restore sites or in approved restructuring plans that have been communicated to affected parties.

A restructuring provision is only recognised when there is a detailed plan and valid expectation has been communicated, covering direct costs necessary for the restructuring.

### Government Grants and Assistance

![Onerous contract assessment under IAS 37, comparing expected benefits with unavoidable costs to determine provision recognition and loss measurement.](https://static.pastpaperhero.com/images/acca-sbr-provisions-and-government-grants-contingent-liabilities-and-onerous-contracts_00.png)

_IAS 37 flow for onerous contracts compares benefits with unavoidable costs and recognises a provision at the lower exit or fulfilment cost._

> **Key Term: government grant**
> Assistance by government in the form of a transfer of resources to an entity in return for past or future compliance with certain conditions.

Grants are recognised when there is reasonable assurance that the entity will comply with the conditions and the grant will be received.

Grants related to income can be either:

- Separately presented as income; or
- Deducted from the related expense.

Grants relating to assets may be:

- Deducted from the carrying amount of the asset; or
- Recognised as deferred income and released to profit or loss systematically over the asset's life.

### Worked Example 1.3

A company receives a \$100,000 grant towards machinery costing \$500,000 with five-year useful life. How can the grant be accounted for?

> **Answer:**
> Either (a) reduce asset cost to \$400,000 and depreciate over five years, or (b) recognise as deferred income and release \$20,000 per year to profit or loss, matching the depreciation expense.

### Exam Warning (Government Grants)

A grant that becomes repayable is accounted for as a revision of an estimate; reverse any related deferred income first, then charge excess repayment immediately to profit or loss.

### Disclosure Requirements

Both IAS 37 and IAS 20 require detailed disclosures around provisions, contingent liabilities, and government grants—including uncertainties, estimation methods, and conditions attached to grants received.

## Summary

Provisions are recognised only when the entity has a present obligation, a probable outflow of resources, and a reliable estimate exists. Contingent liabilities and assets are disclosed but not recognised. Onerous contracts require a provision for the least net cost of fulfillment or exit. Government grants are matched to expenditure when there is reasonable assurance of receipt and compliance. All require transparent disclosure and careful professional judgement.

## Key Point Checklist

_This article has covered the following key knowledge points:_

- Define and recognise provisions under IAS 37
- Distinguish between provisions, contingent liabilities, and contingent assets
- Identify and provide for onerous contracts
- Calculate and record restructuring and environmental provisions
- Explain the recognition and presentation of government grants
- Disclose required details for provisions and government grants

## Key Terms and Concepts

- provision
- present obligation
- contingent liability
- contingent asset
- onerous contract
- government grant


Provisions and government grants - Contingent liabilities and onerous contracts