Distinguish between provisions and contingent liabilities and give examples.

• A. Provisions are recognised for present obligations likely to cause an outflow and estimable (e.g., warranties); Contingent liabilities depend on uncertain future events and are disclosed unless remote (e.g., pending litigation)
• B. Provisions are not recognised; contingent liabilities are recognised when probable.
• C. Provisions are always remote; contingent liabilities are always recognised.
• D. Provisions and contingent liabilities are the same thing.

Answer: (A)

The main idea is recognizing versus disclosing liabilities based on whether the obligation is definite and likely to require an outflow of resources. Provisions are created when there is a present obligation resulting from a past event, it is probable that an outflow of resources will be needed to settle it, and the amount can be estimated reliably. Warranties are a classic example: you expect to incur costs to repair or replace goods within the warranty period, so you book a provision now to cover that estimated future expense.

Contingent liabilities, on the other hand, depend on uncertain future events. You don’t recognize them as liabilities on the balance sheet because the outflow isn’t certain yet; instead, you disclose them in the notes unless the chance of an outflow is remote. Pending litigation fits here: the ultimate cost depends on the court outcome, so you disclose the nature and potential financial impact, if estimable, rather than recognizing a liability now.

So provisions are for present, probable, estimable obligations that will likely require an outflow; contingent liabilities are future-dependent, uncertain obligations that you disclose rather than recognize, except when the risk of an outflow is remote.