Provision
An amount a company sets aside on its balance sheet for a liability that is probable but whose exact amount is not yet known, such as a warranty or a pending legal claim.
In plain language
Some obligations are certain to arise, or very likely to, but the company cannot say exactly how much they will cost until later.
A provision is how accounting handles that. The company books an estimate now, as a liability, rather than waiting until the exact figure is known.
How it works
The workbook: "Provision represents amount set aside for a liability which is yet to be fully quantified... Unlike reserves, which are set aside for unknown purpose, provisions are amount set aside to meet a specific obligation." Common examples it names are retirement benefit obligations and warranty obligations.
Chapter 8.3.1 splits provisions by timing: those towards obligations due beyond 1 year sit under non-current liabilities; those due within a year are short-term provisions, shown under current liabilities.
A worked example
Illustrative. An appliance maker sells 6,00,000 units in a year, each carrying a two-year warranty. Past experience shows 3% of units need a repair, at an average cost of Rs 800 each.
6,00,000 × 3% = 18,000 units expected to need repair
18,000 × Rs 800 = Rs 1,44,00,000 (Rs 1.44 crore) warranty provision
The company books this Rs 1.44 crore as a provision in the year of sale, even though it does not yet know exactly which units will actually need repair or precisely what each repair will cost.
Why NISM asks about it
Chapter 8.3.1 (Balance Sheet) sets out provisions alongside other current and non-current liabilities. Expect a question distinguishing a provision from a reserve, or a computation building a provision from a claims rate and unit cost.
Common exam traps
Where this is taught
Free preparation for NISM Series XVRelated terms
- Contingent liabilityAn obligation that may or may not arise, depending on the outcome of an uncertain future event — a lawsuit, a tax dispute, a guarantee — disclosed in the notes rather than booked in the accounts.
- Off-balance sheet itemAn asset, liability or exposure that does not appear on a company's balance sheet, such as certain leases, contingent liabilities or derivative contracts disclosed only in the notes.
- ReservePart of a company's equity set aside from profit for a general or specific future use, such as a general reserve or a capital reserve — distinct from a provision, which is a liability.
- Qualified audit reportAn auditor's opinion that part or all of a company's financial statements do not give a true and fair view — issued when the auditor disagrees with an accounting policy or finds a serious discrepancy.
- Deferred revenueA liability representing the value of a future obligation owed for revenue already collected in advance — money received but not yet earned.