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The role of probable in defining provisions and contingent liabilities

5 August, 2015 - 14:41

Probable is more than 50% likely to occur because there was a past obligating event. The past obligating event defines a future payment event which is

  1. on a specific date
  2. on demand from the obligating party
  3. linked to another obligating event by specific agreement

A contingent liability suffers from recognition criteria failure, it can't be reliably measured, or isn't probable.

Contingent liabilities become provisions , which are recognised liabilities on financial statements, when they become probable and can be reliably estimated ( measured ).

A reliable estimate of economic burden serves as measurability for provisions: e.g. product warranty provision: if minor repairs cost 5% of the total cost and an estimated 5% of products may require minor repairs within 2 years of sale, and major repairs cost 20% and 1% of products may require major repairs in 2 years, then a provision is made for 5% x 5% + 20 % x 1% of budgeted total sales (0.25% + 0.2% = a 0.45% of sales amount set aside as credit to warranty provision liability account , and the warranty expense of 0.45% recorded at the start of the same period as the expected sales . On a warranty being claimed, cash in bank is credited and warranty provision debited to settle this instance of liability with economic outflow).