Under FRS 102 a claim against a company is provided for only when, at the balance sheet date, the company has a present obligation from a past event, it is more likely than not that it will have to pay, and the amount can be estimated reliably. If payment is possible but not probable, the claim is disclosed as a contingent liability. If the chance of paying is remote, it is neither recognised nor disclosed.

What does FRS 102 require for a legal claim?

Legal claims fall under Section 21 of FRS 102, Provisions and Contingencies. Paragraph 21.4 sets three conditions, all of which must be met before a provision is recognised:

  1. the company has an obligation at the reporting date as a result of a past event;
  2. it is probable, meaning more likely than not, that the company will have to transfer economic benefits to settle it; and
  3. the amount can be estimated reliably.

Paragraph 21.6 explains that the obligation must leave the company with no realistic alternative to settling it, either because it is enforceable by law or because the company has created a valid expectation that it will pay. For a damages claim the obligation, if it exists, is a legal one. The general rules on recognition, measurement and onerous contracts are covered in provisions and contingencies under FRS 102; this page deals with how they apply when someone sues or threatens to sue.

How do you decide whether the company has a present obligation?

With a disputed claim the real question is often whether the company is liable at all. The appendix to Section 21 works through exactly this in Example 9, a customer suing over an injury from a product. When the year 1 accounts were approved, the company’s lawyers advised that it was probable the company would not be found liable, so there was no present obligation and no provision; the matter was disclosed as a contingent liability unless an outflow was remote. A year later the lawyers advised that liability was now probable, so a provision was recognised. The obligating event was the original sale of the product, not the court hearing.

Two points follow from that example. First, the judgement is made on the evidence available up to the date the directors approve the accounts, so up to date legal advice is the main evidence. Second, the past event is the act that caused the claim, such as defective work, a sale or a breach of contract, so a claim that is only threatened can still need a provision if the underlying event happened before the year end.

Provision, contingent liability or nothing: how do the outcomes compare?

Position at the reporting date Treatment Reference
Present obligation, outflow probable, reliable estimate possible Recognise a provision Paragraph 21.4
Possible obligation, or outflow not probable, or no reliable estimate Contingent liability: disclose, do not recognise Paragraphs 21.12 and 21.15
Possibility of any outflow is remote No recognition and no disclosure Paragraph 21.12
Company jointly and severally liable with others Part expected to be met by others is a contingent liability Paragraph 21.12

Paragraph 21.12 defines a contingent liability as either a possible but uncertain obligation, or a present obligation that is not recognised because payment is not probable or cannot be measured reliably. Cases where an amount truly cannot be estimated are rare; a range of outcomes is usually enough to make an estimate.

How is the provision measured, and what about insurance?

Paragraph 21.7 requires the best estimate of the amount the company would rationally pay to settle the obligation, or to transfer it to a third party, at the reporting date. A legal claim is a single obligation, so the most likely outcome may be the best estimate, but the company must still consider other outcomes: if they are mostly higher or mostly lower, the estimate moves accordingly. Where the effect of the time value of money is material, for example a claim expected to take several years to resolve, the provision is discounted at a pre tax rate.

Insurance needs care. Paragraph 21.9 says a reimbursement, such as a professional indemnity or product liability insurance recovery, is recognised as a separate asset only when it is virtually certain to be received, and never for more than the provision. It is shown as an asset and not netted off the provision in the balance sheet, although the expense in the income statement may be shown net of it.

Future legal fees are a separate question. Paragraph 21.6 excludes obligations that arise from the company’s future conduct, so the cost of continuing to defend a case is generally charged as the work is done rather than provided for in advance.

What happens if the case settles after the year end?

Section 32 decides whether later news changes the accounts. Paragraph 32.5(a) treats the settlement of a court case after the year end, which confirms the company had a present obligation at the reporting date, as an adjusting event: the provision is recognised or adjusted, not merely disclosed. By contrast, paragraph 32.7(b) treats an amount the company becomes entitled to through a favourable judgement after the year end as non adjusting; at the reporting date it was a contingent asset. See events after the reporting period for the wider rules.

Example 9 also confirms that a provision recognised in a later year because the legal advice has changed is not the correction of an error, provided the earlier judgement was reasonable on the evidence available when those accounts were approved.

What does a worked example look like?

Illustration only. A design company is sued by a former client for £200,000 over work completed two years ago.

  • Year 1. Solicitors advise that the company has a reasonable defence and that liability is possible but not probable. No provision is made. The note describes the claim as a contingent liability and, where practicable, gives an estimate of its financial effect and the uncertainties.
  • Year 2. After expert reports, solicitors advise that the company will probably be found liable and that the most likely settlement is £120,000. A provision of £120,000 is recognised. The insurer has accepted the claim subject to a £25,000 excess, so a separate insurance asset of £95,000 is recognised because recovery is virtually certain. The income statement may show the net cost of £25,000.

If the insurer had only acknowledged notification and reserved its position, recovery would not be virtually certain and no asset would be recognised; the possible recovery would be disclosed as a contingent asset if it was probable (paragraph 21.16).

What must the notes say?

For a provision, paragraph 21.14 requires a reconciliation of the opening and closing amounts, a brief description of the obligation, the expected amount and timing of payments, the uncertainties and any expected reimbursement. For a contingent liability, paragraph 21.15 requires a brief description and, where practicable, an estimate of the financial effect, an indication of the uncertainties and the possibility of any reimbursement.

Paragraph 21.17 recognises that in extremely rare cases these disclosures could seriously prejudice the company’s position in the dispute. The company may then hold back some detail, but must still give minimum information, including the general nature of the dispute and the fact that, and reason why, the full information has not been given.

Small companies are not excused. Paragraph 1AC.31C of FRS 102 requires small entities to give the disclosures in paragraphs 21.14 to 21.17A, and paragraph 57 of Schedule 1 to the Small Companies and Groups (Accounts and Directors’ Report) Regulations 2008 requires the total of financial commitments, guarantees and contingencies not included in the balance sheet to be stated. Larger companies have the equivalent requirement in paragraph 63 of Schedule 1 to the Large and Medium sized Companies and Groups (Accounts and Reports) Regulations 2008. See FRS 102 Section 1A for small entities.

Is the provision deductible for tax?

HMRC’s Business Income Manual at BIM46510 says a provision is allowable only if it relates to allowable revenue expenditure, complies with generally accepted accounting practice, does not conflict with a statutory timing rule and is estimated with sufficient accuracy. Whether the underlying damages are deductible depends on whether they were incurred wholly and exclusively for the trade and are revenue rather than capital (BIM42951). BIM38525 explains that costs arising from a breach of the law, and costs of settling an action alleging such a breach, are not allowable, while legal expenses in the normal day to day conduct of the trade are likely to be.

What mistakes come up in practice?

  • Waiting for a court judgement before providing, when legal advice already makes liability probable.
  • Providing for the full amount claimed rather than the best estimate of settlement.
  • Netting an insurance recovery against the provision, or recognising one that is not virtually certain.
  • Providing for future defence costs, which relate to future conduct.
  • Omitting the contingent liability note because the claim is thought to be weak, when weak is not the same as remote.
  • Ignoring the effect of a large claim on the going concern assessment.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 19 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.