DIFFERENCE BETWEEN PROVISION AND CONTINGENT LIABILITY
Provision
It is the present obligation that arises due to previous events. Provision decreases asset values. This is for bad debts and doubtful debts are commonly recorded debts.
Over-provision or under-provision is recognized by comparing with the previous years and is charged in an income statement. The provision amount is decided on the company’s policy.
A provision is a decrease in asset value and should be recognized when a present obligation arises due to a past event. The timing as to when the said obligation arises and the amount is often uncertain.
Commonly recorded provisions are provisions for bad debts (debts that cannot be recovered due to insolvency of the debtors) and provisions for doubtful debts (debts that are unlikely to be collected due to possible disputes with debtors, issues with payments days, etc.) where the organization makes an allowance for the inability to collect funds from their debtors due to nonpayment.
Provisions are reviewed at the financial year end to recognize the movements from the last financial year’s provision amount and the over-provision or under-provision will be charged to the income statement.
Contingent liability
It is recognised based on future events and a reasonable amount is estimated. If the estimation amount is not possible, then these may not be recorded in financial statements.
Contingent liabilities are possible obligations whose existence will be confirmed by uncertain future events that are not wholly within the control of the entity. An example is litigation against the entity when it is uncertain whether the entity has committed an act of wrongdoing and when it is not probable that settlement will be needed.
Contingent liabilities also include obligations that are not recognised because their amount cannot be measured reliably or because settlement is not probable. Contingent liabilities do not include provisions for which it is certain that the entity has a present obligation that is more likely than not to lead to an outflow of cash or other economic resources, even though the amount or timing is uncertain.
A contingent liability is not recognised in the statement of financial position. However, unless the possibility of an outflow of economic resources is remote, a contingent liability is disclosed in the notes.
Differences between Provision and Contingent Liabilities
The main differences between Provision and Contingent Liabilities are as follows:
| Provision Liability | Contingent Liability |
| If the management estimates that it is probable that the settlement of an obligation will result in outflow of economic benefits, it recognises a provision in the balance sheet. |
If the management estimates that it is less likely that any economic benefit will outflow from the firm to settle the obligation, it discloses the obligation as a contingent liability |
| Provision liability reduces an asset’s value because of a present obligation arising out of a past event. | Contingent liability is a potential liability that can occur at a future date due to events beyond a company’s control. |
| The event which can result in a provisional liability may or may not occur. | The event which can result in a contingent liability will occur. |
| Occurrence is conditional or not certain | Occurrence is certain |
| The estimated amount of the provisional liability is not certain. | The estimated amount of the contingent liability is largely certain. |
| Any increase or decrease in provision liability gets recorded in the Profit and Loss Account. | The Profit and Loss Account does not record a contingent liability. |
Some of the examples of a provision liability are as follows:
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Some of the examples of a contingent liability are as follows:
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