Month End Glossary

Provision

A provision is an accounting term that refers to an amount set aside from profits to cover future liabilities or expenses, such as anticipated legal costs, known bad debts, or unforeseen operational costs.

A provision is an amount recognized in the financial statements to account for likely but uncertain obligations or losses. Provisions are different from liabilities, as their exact timing or amount is not certain, while liabilities are definite and measurable obligations. For example, a company might create a provision for warranties to cover repairs that may be required for products sold. Another example is the allowance for doubtful debts, where a business estimates the value of receivables it expects to be uncollectible over a certain period.

Provisions are made by charging the anticipated amount as an expense on the income statement and recording it as a provision under the liabilities section of the balance sheet. Common types of provisions include provisions for bad debts, provisions for restructuring, and provisions for legal claims. These are essential in adhering to accounting principles such as the prudence concept, which ensures that expenses are recorded when they are probable rather than certain.

Creating provisions helps businesses avoid overstating profits and provides a more accurate representation of financial health. It is also a requirement under the International Financial Reporting Standards (IFRS), specifically IAS 37, which governs provisions, contingent liabilities, and contingent assets.

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