Under IAS 37, a provision must be recognised when, and only when, all three of the following criteria are simultaneously met (IAS 37.14):

• There is a present obligation (legal or constructive) as a result of a past event
• It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation
• A reliable estimate can be made of the amount of the obligation

Each criterion deserves careful examination in practice.

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1. Present Obligation from a Past Event

The obligating event must have already occurred, creating either a legal obligation (arising from contract, legislation, or other operation of law) or a constructive obligation (arising from an entity's actions where it has created a valid expectation in other parties that it will discharge the obligation) (IAS 37.10). Crucially, the entity must have no realistic alternative but to settle. Future intentions alone — such as a planned restructuring not yet announced — do not create a present obligation (IAS 37.18–19).

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2. Probable Outflow of Economic Benefits

"Probable" is defined under IAS 37 as more likely than not, meaning the probability of outflow exceeds 50% (IAS 37.23). If an outflow is possible but not probable, the item is disclosed as a contingent liability rather than recognised as a provision (IAS 37.86). If the possibility is remote, no disclosure is required at all (IAS 37.28).

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3. Reliable Estimate of the Obligation

Management must be able to make a reliable estimate of the obligation's amount. IAS 37 acknowledges that in rare cases a reliable estimate cannot be made, in which case recognition is precluded and the item is disclosed as a contingent liability (IAS 37.26). In practice, this criterion is rarely the blocking factor — some degree of estimation uncertainty is inherent in provisions and is accommodated through the measurement guidance.

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Measurement Considerations

When recognition criteria are met, the provision is measured at the best estimate of the expenditure required to settle the present obligation at the reporting date (IAS 37.36). For large populations of similar obligations (e.g., warranty provisions), the expected value method is used. For a single obligation, the most likely outcome may be more appropriate, adjusted for other possible outcomes (IAS 37.39–40). Where the time value of money is material, provisions are discounted to present value using a pre-tax risk-free discount rate (IAS 37.45–47).

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Common Practical Examples

• Warranties — a provision is recognised at the point of sale when a legal obligation exists and past experience allows reliable estimation
• Onerous contracts — a provision is required once expected costs exceed expected benefits (IAS 37.66)
• Restructuring provisions — only recognisable once a detailed formal plan exists and has been communicated to affected parties (IAS 37.72–74)
• Environmental decommissioning — a provision arises the moment contamination occurs or an asset is installed, creating a legal or constructive obligation

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Key Distinction to Remember

A provision differs from other liabilities in that timing or amount is uncertain. If both are known, the liability is simply an accrual, not a provision. This distinction, while accounting-policy neutral in outcome, matters for disclosure and note presentation.