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Provisions and liabilities: Do you know the difference?

A1blProvisions and liabilities – words that are often used interchangeably but for accounting purposes they are not the same. To determine whether expenditure is a provision or a liability depends on the certainty, timing and amount of the expenditure.

The classification of provisions and liabilities depends on the answers to the questions as set out in the table below:  A1 table

The definitions of the different provisions and liabilities are discussed in more detail below, together with an example of each one.

  1. Provisions

A provision is a present obligation for future expenditure of which the amount can be estimated reliably but where there is uncertainty about the timing of the payment.

Example:

Some of our employees have not taken all their vacation leave. According to their employment contracts, they have the option of taking the outstanding leave days off or ask for it to be paid out instead.

Discussion:

(a)    Certainty:  We are certain that we will have to pay as we have a contractual agreement with the employees.

(b)   Timing: It is uncertain when we will have to pay because the employees can ask to take the leave or receive the payout at any time in the future.

(c)    Amount: We can reliably estimate the amount by multiplying the number of untaken leave days per employee by the employee’s average salary per day.

  1. Liabilities

2.1 Trade payables

A trade payable is a liability to pay for goods or services that have already been received or supplied, and have been invoiced by the supplier.

Example:

A supplier has delivered clothing to our company. The supplier already invoiced us for the clothing but we still have to pay them.

Discussion:

(a)    Certainty: It is certain that we will have to pay for the clothing as we have received it.

(b)   Timing: We will pay according to the terms as set out on the invoice of the supplier.

(c)    Amount: The amount is determined by the supplier’s invoice.

2.2 Accruals

An accrual is a liability to pay for goods or services that have been received or supplied, but have not yet been paid or invoiced. Sometimes it is necessary to estimate the amount or timing of an accrual but the degree of uncertainty is less than for provisions.

Example:

We ordered clothing from a supplier and they have already delivered it to us but we are still waiting for them to send us their invoice.

Discussion:

(a)    Certainty: We are certain that we have to pay the supplier as we have received the clothing.

(b)   Timing: It depends on the terms of the invoice and will only be known with certainty after we have received the invoice from the supplier.

(c)    Amount: We know what amount we ordered for but the amount will only be confirmed after we received the invoice.

2.3 Contingent liabilities

With a contingent liability, it is uncertain whether the business will be liable for payment in future. The timing and the amount of the potential payment is conditional upon the results of a future event.

Example:

A model who bought clothing from us for a photo shoot has sued us. She washed the clothes and the colours faded so much that she had to cancel the photo shoot because she could not wear the faded clothes. She has sued us for loss of income because she could not do the photo shoot. The court case is still ongoing and it is not clear yet whether the business will be liable to pay her for the loss of income she suffered.

Discussion:

(a)    Certainty: We will only know if we have to pay when the court case is finished.

(b)   Timing: It will depend on when the court case finishes.

(c)    Amount: It will depend on the amount that the judge determines.

It is clear from the above content that the classification of provisions and liabilities is a grey area and open to different angles of interpretation. Classification should always be supported by the facts specific to the situation and if in doubt, rather get professional advice. 

This article is a general information sheet and should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions or for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. 

Reference List:

  • saica.co.za
  • IFRS for SMEs – A summary by W. Consulting and SAICA
  • Income Tax Act, No 58 of 1962
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