Proposed changes to provisions under IFRS® Accounting Standards

From the IFRS Institute – March 14, 2025

Authors: Valerie Boissou, Ingo Zielhoff, and Kieran Fearon

The International Accounting Standards Board (IASB) has proposed amendments to IAS 37 to enhance the recognition and measurement of provisions. On recognition, the IASB proposes to withdraw the controversial existing guidance on levies and introduce a new three-step test for determining whether a present obligation exists. On measurement, the IASB proposes to include all direct costs and use the risk-free discount rate in measuring provisions. This proposal aims to ensure more accurate and timely recognition of liabilities, improve clarity and consistency in financial reporting, and address challenges in accounting for complex transactions and uncertainties. It could result in larger provisions recognized over time and at an earlier date.

Background and rationale

IAS 37, originally issued in 1998, is the one-stop-shop guidance for provisions and contingencies under IFRS Accounting Standards. Over the years, the business environment has evolved, and companies have encountered increasingly complex transactions and uncertainties, in particular in relation to climate-related commitments and threshold-based obligations. This has led to questions about how to apply IAS 37 to determine if a present obligation exists, when to recognize a provision, which costs to include in measuring a provision, and which discount rate to use in discounting a long-term provision.

In response to these challenges, the IASB has issued an exposure draft¹ to amend IAS 37 to clarify the related requirements and withdraw related interpretations: IFRIC 6, Liabilities arising from Participating in a Specific Market and IFRIC 21, Levies.

Recognition of provisions

One of the key amendments proposed by the IASB seeks to enhance the recognition guidance for provisions. IAS 37 currently requires recognizing a provision when all three criteria are met: 

1. there is a present obligation as a result of a past event; 
2. it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and 
3. a reliable estimate can be made of the amount of the obligation. 

The proposed amendments relate to Criterion 1 and introduce three new tests for determining if a present obligation exists. The chart below illustrates the proposed updates.

Obligation test

Under the proposal, in determining whether a company has an obligation, it has to answer three questions.

1. Is there a mechanism that imposes a responsibility if the company obtains specific economic benefits or takes actions?
2. Does the company owe that responsibility to another party?
3. Does the company have a practical ability to avoid the responsibility if it obtains benefits or takes action?

Currently, a company considers its ability to avoid settling its obligation when determining whether it has a present obligation arising from a past event. Under the proposal, the first test on whether the company has an obligation will shift from the ability to avoid the transfer of economic resources to the practical ability to avoid the obligation under the law or another specific mechanism. As a result, companies may need to recognize some provisions over time and at an earlier date.

Transfer test

The proposal would introduce a new, specific test, which would require a company to assess whether:

1. its obligation has the potential to require the company to transfer an economic resource; and 
2. the transfer of economic resources is to another party.

The second test does not consider the probability of the transfer, which remains part of Criterion 2 – i.e. whether an outflow of resources is probable. A transfer of economic resources is not an exchange of economic resources, unless the terms of the exchange are unfavorable to the company. A transfer may also be contingent upon a specific uncertain future event. 

Past event test

Under the proposal, a company has a present obligation as a result of a past event if it has:

• obtained economic benefits or taken action; and
• consequently, will or may need to transfer an economic resource. 

Under current IAS 37, a past event is considered to arise at a point in time regardless of its nature. Under the proposal, if a company obtains economic benefits or takes the action over time, then the present obligation would arise over time.

The proposal generally does not impact Criterion 2 and Criterion 3. 

Measurement of provisions

Costs included in measuring a provision

The measurement of provisions has been another area of concern for companies because current IAS 37 does not provide specific guidance on which costs to include in measuring a provision and approaches may have varied depending on the nature of the provision. For example, an onerous contract provision would generally include incremental costs and an allocation of other direct costs whereas a legal provision may include only incremental costs related to payments to external lawyers and the claimant. 

Under the proposal, a company includes all direct costs when measuring a provision – i.e. incremental costs and an allocation of other costs that relate directly to settling the obligation – regardless of the nature of a provision. As a result, some provisions may become larger. Companies may require new processes to identify all direct costs and an allocation method.

Discount rate used for long-term provisions

In applying IAS 37, the approach to determining the discount rate for long-term provisions varies between companies – i.e. some use a risk-free rate or others adjust the rate for non-performance. The IASB proposes to use a risk-free discount rate and to provide new disclosures: the discount rate used in measuring provisions and the approach used to determine that rate.

Application of the recognition and measurement requirements

The proposal includes updates to the application guidance in the standard (e.g. for restructuring provisions) as well as including several updated and new examples in the standard’s implementation guidance, including examples for obligations previously covered by IFRIC 6 and IFRIC 21.

Implications for restructuring provisions

The proposed amendments remove reference to a ‘constructive obligation’ and instead refer to a ‘present obligation for the cost of a restructuring’. In addition, the proposal aims to provide clearer guidance on the types of costs that can be included in a restructuring provision, such as:

• statutory, contractual or constructive obligations to pay termination benefits to employees whose roles are made redundant by the restructuring, to the extent that the obligations relate to past employment; and
• contractual obligations to pay penalties for cancelling executory supply contracts the company entered into before the end of the reporting period.

Implications to threshold-based obligations

IAS 37 currently does not provide specific guidance on threshold-based obligations and companies apply IFRIC 21. Under that guidance, companies recognize related provisions at a single point in time when the threshold is reached. 

Under the proposal, a present obligation would instead accumulate as the company carries out the activity linked to the threshold that it expects to exceed at the end of the compliance period. For example, in relation to an emissions obligation, a present obligation will arise as the company emits pollutants if it expects to exceed the emissions threshold for the compliance period. That means that the company may need to recognize a provision earlier and over time. This would also require management to make new judgments and estimates throughout the reporting period, including whether a threshold will be exceeded.

Comparison with US GAAP

Several key differences between IFRS Accounting Standards and US GAAP would remain post amendment of IAS 37, with US GAAP having multiple standards relating to different types of contingencies and IFRS Accounting Standards having only one. Some key differences include: 

• Recognition criteria: IAS 37 would continue to require provisions when there is a present obligation, probable outflow of resources and reliable estimate. US GAAP, under ASC 450, recognizes loss contingencies if a liability is probable and can be reasonably estimated. Under US GAAP, ‘probable’ means likely to occur, which is a higher recognition threshold than under IFRS Accounting Standards.
• Measurement approach: IAS 37 would continue to use the best estimate approach, considering risks and uncertainties, and discounting when significant. Measurement approaches vary under US GAAP depending on the type of contingency – e.g. asset retirement obligations are measured at fair value under ASC 410² whereas loss contingencies in scope of ASC 450³ are measured using a best estimate method.
• Types of costs included: IAS 37 would require incremental costs and an allocation of other costs that relate directly to settling the obligation to be included in the measurement. Cost to include under US GAAP depends on the type of contingency.

The takeaway

If finalized as currently drafted, the proposed amendments to IAS 37 might be most impactful to companies with material threshold-based obligations currently recognized under the levies guidance in IFRIC 21. However, all companies should analyze the potential impact of the proposed amendments on their provisions, both from a recognition timing as well as measurement perspective. 

Given the broad scope of obligations falling under the scope of IAS 37, most companies are expected to be impacted by the amended guidance, requiring new judgments and updates to related processes to support the recognition and measurement of provisions at period end. It may be necessary to amend related accounting documentation and policies even if the recognition and measurement does not materially change.