What is the difference between Provision and Liability in accounting

Why do auditors keep asking company’s lawsuit status? Why is it so important?

You know the lawsuit is a very slow and irritating one! How I know!

What is the difference between ‘Provision’ and ‘Liability’?

Provision: a liability of uncertain timing or amount.

Liability:

- present obligation as a result of past events

- settlement is expected to result in an outflow of resources (payment)

Provision :

3 criteria are required to be met before a provision can be recognised. These are:

- There needs to be a present obligation (legal/ contractual) from a past event

- There needs to be a reliable estimate (best estimate/ expected value)

- There needs to be a probable outflow (high chance)

What is the difference between ‘Contingent liability’ and ‘Contingent asset’?

These two categories should only be disclosed in financial statements but not recognised in accounts.

Contingent liability :

- a possible obligation depending on whether some uncertain future event occurs, or

- a present obligation but payment is not probable or the amount cannot be measured reliably

Contingent asset :

- a probable asset that arises from past events, and

- whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity.

Example

Contingent Liability:

- Pending lawsuit, product warranty or pending investigation

- The outcome is unknown

- If possible to lose, disclose a contingent liability

- If probable to lose, recognise the provision

Contingent Asset :

- Pending lawsuit, insurance claim

- The outcome is probable

- If probable to receive income (by lawyer or insurance company), disclose contingent asset

- If virtually certain to receive income (subsequently proof by supporting), recognise asset

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