Under FRS 102 Section 21 a business recognises a provision only when it has a present obligation from a past event, an outflow of resources is more likely than not, and the amount can be estimated reliably. The provision is measured at the best estimate of what the business would rationally pay to settle the obligation, or transfer it to a third party, at the reporting date. A possible obligation, or a present obligation that fails the probability or reliability test, is a contingent liability: it is disclosed in the notes rather than recognised, unless the chance of an outflow is remote.

What counts as a provision under Section 21?

Paragraph 21.1 defines a provision as a liability of uncertain timing or amount. Paragraph 21.3 makes clear that the word “provision” used for depreciation, impairment of assets or uncollectible receivables is outside the section altogether, because those items reduce the carrying amount of an asset rather than create a liability. Bad debt allowances are dealt with under the financial instruments rules instead (see bad debts in the accounts and for tax).

Paragraph 21.1B also excludes financial instruments within Sections 11 and 12, insurance contracts within FRS 103, and executory contracts, meaning contracts where neither party has performed or both have performed to an equal extent, unless those contracts are onerous. Micro entities using FRS 105 apply the equivalent rules in FRS 105 Section 16, as HMRC notes at BIM46515.

When must a provision be recognised?

Paragraph 21.4 sets three conditions, all of which must be met:

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

Paragraph 21.6 explains that the first condition means the business has no realistic alternative to settling. That can be a legal obligation enforceable by law, or a constructive obligation where the business’s own past conduct has created valid expectations in other people. Obligations that will only arise from the future conduct of the business never qualify, however likely they are. The standard’s example is a factory owner who must fit smoke filters: it could avoid the cost by changing how it operates or selling the factory, so there is no provision.

The provision is recognised as a liability and an expense, unless another section requires the cost to be included in an asset such as inventories or property, plant and equipment (paragraph 21.5). Reinstatement costs under a lease are the common example, covered in dilapidations provisions for leased premises.

What can never be provided for?

  • Future operating losses. Paragraph 21.11B prohibits them. An expected loss in a segment may instead point to impairment under Section 27.
  • Restructuring announced only in the boardroom. Paragraph 21.11C requires a detailed formal plan and a valid expectation in those affected, created by starting the plan or announcing its main features to them. In the appendix, a board decision on 12 December that was not communicated before the 31 December year end gives no provision; a plan communicated to customers and staff before the year end does.
  • Costs of adapting to new rules. The appendix example of staff retraining after a change in the tax system concludes that no provision is made until the retraining itself takes place.

How is a provision measured?

Paragraph 21.7 requires the best estimate of the amount needed to settle the obligation at the reporting date. Where a large population of items is involved, such as product warranties, the estimate weights all possible outcomes by their probabilities, using the mid point where every point in a continuous range is equally likely. For a single obligation, such as one legal claim, the most likely outcome may be the best estimate, but the business must still consider whether other outcomes are mostly higher or lower and adjust accordingly.

Where the time value of money is material, the provision is discounted using a pre tax rate reflecting current market assessments and the risks specific to the liability. Those risks go into either the rate or the cash flows, never both. Other measurement rules worth knowing:

  • gains from the expected disposal of assets are excluded (paragraph 21.8);
  • an expected reimbursement, for example from an insurer, is recognised as a separate asset only when it is virtually certain, is capped at the amount of the provision and is not offset against it on the balance sheet, although the expense may be shown net in profit or loss (paragraph 21.9);
  • only the expenditure the provision was set up for can be charged against it (paragraph 21.10);
  • provisions are reviewed at every reporting date, with changes taken to profit or loss unless the provision was originally included in the cost of an asset, and the unwinding of any discount shown as a finance cost (paragraph 21.11).

What does a warranty provision look like?

The appendix to Section 21 works through a manufacturer that sells goods for CU1,000,000 with a warranty. Experience shows that 90% of products need no repair, 6% need minor repairs costing 30% of the sale price and 4% need major repairs or replacement costing 70% of the sale price.

Outcome Calculation Expected cost
No repair 1,000,000 x 90% x 0 CU0
Minor repair 1,000,000 x 6% x 30% CU18,000
Major repair 1,000,000 x 4% x 70% CU28,000
Total CU46,000

Because the costs are expected to be paid over the following three years, the standard discounts them using government bond rates and recognises a provision of CU41,846. The obligating event is the sale with a warranty, so the provision covers products already sold, not future sales.

When is something a contingent liability instead?

Paragraph 21.12 defines a contingent liability as either a possible but uncertain obligation, or a present obligation that fails the probability or reliable estimate condition. It is not recognised, except for certain contingent liabilities assumed in a business combination. It must be disclosed under paragraph 21.15 unless the possibility of an outflow is remote, with a brief description and, where practicable, an estimate of the financial effect, the uncertainties and any possible reimbursement.

Position at the reporting date Treatment
Present obligation, outflow probable, reliable estimate Recognise a provision
Possible obligation, or outflow not probable Disclose as a contingent liability
Possibility of outflow is remote No recognition or disclosure

The court case example in the appendix shows how the answer can change. Where lawyers advise at the first year end that the business will probably not be found liable, the claim is a contingent liability. When developments mean liability becomes probable a year later, a provision is recognised in that later year, and it is not a prior year error, because the earlier accounts reflected the evidence available when they were approved. That distinction is explained further in accounting policies, estimates and errors.

Contingent assets work the other way. Paragraph 21.13 prohibits recognising them; they are disclosed when an inflow is probable, and once the inflow is virtually certain the asset is no longer contingent and is recognised.

What must be disclosed, including by small companies?

For each class of provision paragraph 21.14 requires a reconciliation of opening and closing amounts, showing additions, amounts used and unused amounts reversed, plus a description of the obligation, the expected timing, the uncertainties and any expected reimbursement. Comparatives for the reconciliation are not required. Small entities applying Section 1A must now give the disclosures in paragraphs 21.14 to 21.17A under paragraph 1AC.31C, in addition to the company law requirement in paragraph 57 of Schedule 1 to the small companies regulations to state the total of financial commitments, guarantees and contingencies not included in the balance sheet. See FRS 102 Section 1A for small entities.

Are provisions deductible for tax?

HMRC’s Business Income Manual at BIM46510 says a provision is allowable only if it relates to allowable revenue expenditure rather than capital, is in accordance with generally accepted accounting practice, does not conflict with a statutory timing rule, and is estimated with sufficient accuracy. At BIM46555 HMRC accepts that where directors have exercised reasonable judgement and reached a GAAP compliant figure, an officer is not entitled to substitute a different figure just because another view is possible, and that inaccuracy should normally lead to a more accurate estimate rather than disallowing the whole provision.

Statutory timing rules override the accounts. Under section 1288 of the Corporation Tax Act 2009 and section 36 of the Income Tax (Trading and Other Income) Act 2005, any element of a provision for employee remuneration is deductible only if it is paid within nine months of the end of the period (BIM46565). The general capital and revenue rules are covered in capital or revenue expenditure.

What mistakes come up in practice?

  • General “rainy day” provisions with no identifiable obligation, which fail paragraph 21.4 and will not be allowed for tax.
  • Providing for future repairs of assets the business owns. HMRC notes at BIM46535 that these are not permitted under Section 21; a significant part needing regular overhaul is depreciated separately instead.
  • Netting an insurance recovery against the provision on the balance sheet, or recognising the recovery before it is virtually certain.
  • Using a provision set up for one purpose to absorb unrelated costs, contrary to paragraph 21.10.
  • Omitting the contingent liability note for a live claim because the directors are confident of winning, when the possibility of an outflow is not remote.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.