Liabilities, provisions, and contingent liabilities are closely related terms and can easily be confused with one another. In this post, we’ll see the differences between these terms.
All these terms are related to the obligations of an entity, the settlement of which is likely to result in outflow of economic resources. So, in terms of certainty of obligations, you can rank these terms in the following order:
- Contingent liability
If there is a present obligation as a result of past events, the settlement of which is likely to result in an outflow of economic resources, and the amount and timing of the obligation are also certain, then the obligation will be termed as liability and must be recorded in the books of account.
Provision is also a liability but with uncertain timing or amount.
Contingent liability is either:
- a possible obligation, or
- a present obligation but is not recognized as provision because the outflow of resources is not probable, or the amount of the obligation cannot be measured reliably.
Provisions and contingent liabilities can be confused as the obligations are not certain. Following table can be helpful in evaluating an entity’s obligations.