Financial Accounting: In an Economic Context

PROVISIONS VS. CONTINGENT LIABILITIES: THE “DEVIL IS IN THE DETAILS”

Like most companies that publish IFRS-based financial statements, Unilever, a Dutch consumer-goods manufacturer, reports a balance sheet account called “provisions” with a sizable balance. Unilever's 2008 balance sheet, for example, includes a 377 million-euro provision classified as a current liability as well as a 646 million-euro provision classified as a long-term liability. The accounts consist of a collection of accrued liabilities where obligations exist related to past events, and reliable estimates can be made for the likely outcomes. Examples include estimates for unresolved legal and tax disputes, restructuring provisions involving estimated costs associated with projected factory closings and employee layoffs (e.g., severance pay), and other costs that are probable and can be reliably estimated. In these ways, provisions under IFRS are very similar to contingent liabilities under U.S. GAAP.

However, there are important differences in how these concepts are applied. Provisions are more readily booked than contingent liabilities because under IFRS provisions are accrued when the obligation is “more likely than not,” while under U.S. GAAP contingent liabilities are accrued when “highly probable,” which is a much higher threshold. Further, under IFRS non-current provisions are valued at the present value of the future expected cash flows; contingent liabilities under U.S. GAAP are valued at undiscounted ...