Provision - Meaning and Examples

What is the Definition of Provision?

In the field of financial accounting, under the International Financial Reporting Standards, a provision is an account that records the present liability of an entity. This liability is recorded in the balance sheet of the concern to match its related expenses. According to the principle of GAAP, a provision is an entity’s expense, while according to IFRS provision is a liability.  

A provision can be described as a liability of uncertain timing or an amount. A liability, in turn, is a present obligation of the entity which arises from past events. The settle of this liability is expected from the outflow of resources which embodies economic benefits. 

What is Provision in Accounting?

Provisions in Accounting are to be described as an amount that is set aside to cover an expense in the future which may occur in all probability. This means this is the reduction in the value of an asset. 

This is the fund that is to be put aside by a company to cover the anticipated losses in the future. Provision is a liability that responds to an uncertain expense. Provisions are listed on a firm’s balance sheet.

These provision amounts are to be estimated. While conducting a financial report, these provisions are recorded as the current liability on the balance sheet, and then it is matched to the appropriate expense account on the income statement.

Why Are Provisions Created?

Provisions are created for a specific purpose, creation of these provisions are important because they account for certain company expenses, which is to be paid in the same year. The creation of the provision is important as it also makes the company’s financial statements more accurate.

These provisions are not a form of savings, as the expenses are ‘probable’, the amount which is set aside and is expected to be spent.

Is a Provision a Reserve?

The direct answer to this question is, no provision is not considered as a reserve.

A reserve or the reserve fund is such a fund that is formed by allocating the money from the profit made by the company for a specific purpose, while a provision is a fund that is allocated for a specific expense. A reserve is a fund that is typically liquid, these funds can be analyzed immediately, like for example, from the savings account. 

An example of an entity that is using a reserve fund would be an Owners’ Association. The company may also have a reserve fund for the unscheduled repairs. They exactly do not know what these repairs will be for, or precisely with what the costs are associated, they only know that the repairs will be required at some point in time. 

An example of a provision could be an automobile company, which sets aside its own money for the warranty repairs for the last year. 

Example of Provision 

The examples of provisions are listed as below: 

  • Accruals

  • Asset impairments

  • Bad debts

  • Depreciation

  • Doubtful debts

  • Guarantees (product warranties)

  • Income taxes

  • Inventory obsolescence

  • Pension

  • Restructuring Liabilities

  • Sales allowances

What Are Tax Provisions?

Tax provisions are the amount that is set aside specifically for paying a company’s income taxes. This is done to calculate the tax amount which the business owes a business. This provision is required to adjust its gross income by the number of tax deductions that it is claiming.

Tax deductions, meals, interest expenses, depreciation allowances, holiday parties, etc may also be included. After the calculations are done, the total tax amount which the company determines it owes can be allocated on its books in a term of provision, which is known as a “tax provision”.

FAQs (Frequently Asked Questions)

1. Explain the Meaning of Liability.

Ans. A liability is something that a person or a company owes to third parties. A Liability is usually a sum of money, which is settled over time through the transfer of economic benefits including money, goods, or services. The liabilities are recorded on the right side of the balance sheet. In the section of liabilities, we have loans, accounts payable, mortgages, deferred revenues, bonds, warranties, and the accrued expenses.

Liabilities are quite a vital aspect of a company as they are used to finance operations that are used to pay for large expansions. These help the business to grow efficiently, as with the help of liability the business owner does not have to think twice to purchase a bulk of quantity, to hit the huge demand in the market and ultimately earn a profit that will also pay off the liabilities well enough. 

2. Define Income Statement

Ans. The income statement shows the company’s revenue, minus its expenses, and it suffered losses. Sometimes a “net income statement” or a “statement of earnings”, the income statement is the most important financial statement in the financial accounting, along with this, the balance sheet and the cash flow statement or the statement of cash flows is included.

The income statement is also known as the profit and loss statement, this is the statement of operation, or the statement of financial result or income, or earnings statement of a company.

3. Is Bad Debt and Doubtful Debt the Same?

Ans. The key difference is in the wording itself. Bad debts are those which cannot be collected by the business anymore, and will generally be a loss for the company. While Doubtful debts, in comparison, are unlikely to be collected, but there is still the possibility of receiving the payment from these debts for these outstanding balances, even if partial amount.