Differences between Provision and Contingent Liabilities

Provision Liability

A provision is a decrease in the value of an asset. It is recognised only when a present obligation takes place due to an event in the past. These Provisions are subject to review at the end of a financial year, and it helps to reveal if there are any changes within the provision amount from the previous year. Any over-provision or under-provision gets recorded in the income statement. Some examples of provisions are as follows:

  • Provision for bad debts: These are debts that an organisation cannot recover because the debtors have become insolvent.
  • Provision for doubtful debts: These are debts the organisation may not be able to collect because of possible disputes with debtors

These liabilities get recorded in a company’s financial statements, and any decrease or increase in provision liabilities gets recorded in the Profit and Loss Account.

Contingent Liability

Contingent liabilities are those potential liabilities that can occur at a future date. This potential liability is because of an uncertain event that is beyond the company’s control. A contingent liability gets recorded in the balance sheet in two conditions:

  • The probability that the contingent liability will take place is certain.
  • The company can determine the extent of contingent liability.

These liabilities will arise in the future because of certain events. These events had either already taken place in the past or will occur in the future. Examples of contingent liabilities include product warranties, outstanding lawsuits, debts, etc.

These liabilities do not get recorded in the financial statements of a company. But they are present as a footnote in those statements.

Differences between Provision and Contingent Liabilities

The main differences between Provision and Contingent Liabilities are as follows:

Provision Liability

Contingent Liability

Definition

Provision liability reduces an asset’s value because of a present obligation arising out of a past event.

Contingent liability is a potential liability that can occur at a future date due to events beyond a company’s control.

Certainty of the event

The event which can result in a provisional liability may or may not occur.

The event which can result in a contingent liability will occur.

Estimate of the liability

The estimated amount of the provisional liability is not certain.

The estimated amount of the contingent liability is largely certain.

Profit and Loss Account

Any increase or decrease in provision liability gets recorded in the Profit and Loss Account.

The Profit and Loss Account does not record a contingent liability.

Examples

Some of the examples of a provision liability are as follows:

  • Provision for bad debts
  • Provision for doubtful debts

Some of the examples of a contingent liability are as follows:

  • Product warranties
  • Outstanding Lawsuits
  • Pending Investigations
  • Debts

Conclusion

The differences in Provisional and Contingent Liabilities highlight the nature of these contingencies and how the company deals with them. It is important to note that a company may have to account for these liabilities while conducting its business.

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