Provision - What is a provision?

Defined: An amount set aside from profits in the accounts of an enterprise for a known liability, though the specific amount of the liability may not be known, or for the diminuation of the value of an asset.

An amount from profits that has been put aside in a company's accounts to cover a future liability is called a provision.

A provisions main purpose is to allow a current year’s balance to become more accurate. This is because there may be costs that could be accounted for in either the previous financial year, or the current financial year. Costs that belong to one specific year could be quite misleading if accounted for in the future or in the past, depending on the circumstances.

A few facts about provisions

Though it may seem to be, a provision is in fact not a form of saving.

During accounting, provisions will be recognized on the balance sheet and also expensed on the income statement, and the resulting impact of a provision is a reduction in the firm's equity.

Setting aside a provision

There are a number of factors that could prompt provisions for liabilities, however there are certain criterions that must be fulfilled before one may view an obligation as a provision, such as:

The company must perform a reliable amount of regulatory measurement of that obligation. The measurement must be made by company management. It must be probable that obligation results in a financial drag on economic resources. An obligation must be a result of events that will advance the balance sheet date, and could result in a legal or constructive obligation. An obligation must have been determined to be probable, but not certain. It must be estimated to have a probability of occurring of more than 50%.

What could a provision be?

Common provisions are:

Restructuring Liabilities Provisions for bad debts Guarantees Depreciation Accruals Pension

Provision for bad debts

A provision for bad debts is one that has been calculated to cover the debts during an accounting period that are not expected to be paid.

A general provision is not allowed as a deduction for tax purposes.

A specific provision, in which specific debts are identified, is allowed as a tax deduction if there is documentary evidence to indicate that these debts are unlikely to be paid.