Liability vs Provision
Liability and provision are accounting terms that are spread all over financial statements on the obligation side of the statement. While liability and provision are differentiated on some accounts in some countries, accountants in some other countries treat them as same and make no differentiation. This article attempts to resolve this dichotomy in obligations of a business by looking at features of both concepts.
Any present obligation that comes about because of an earlier event or events in a business is called a liability. The settlement or clearance of this obligation in future leads to a cash outflow that is reflected in the financial statement of the business. A liability may be any borrowing on part of the company or business from a bank or an individual in anticipation of improvement of business or personal income. Such liability needs to be met in a short duration of time in future. It may arise out of a legal agreement in past or it may be constructive obligation such as a company’s policy to compensate dissatisfied or disgruntled customers. One definition that is considered most common is that given by IASB, and is as follows.
“A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits”.
Provision is a term that is confusing in some accounting practices. However, even where it is used, such as US GAAP, a provision implies an expense. When it comes to IFRS which is considered to be the international accounting standard, provision refers to liability. So if you are preparing accounts according to US GAAP, you would use the word provision when setting aside a figure for Income Tax payment saying it is Income Tax expense whereas in IFRS, the same amount is a liability for Income taxes.
What is the difference between Liability and Provision?
• In a broader sense, provision is nothing, but liability, and considered an obligation of a business to be met in near future implying cash outflow.
• However, on closer inspection, provision appear to be a special type of liability.
• This is because of certainty that is normally associated with liability, and which is lacking in the case of provision.
• This means that we are accepting provision and liability to be similar, but not saying this clearly, but accepting them as two points on a continuum.