IAS 37 - How do you measure a Provision?
Provisions under IAS 37: Most Likely Outcome vs Expected Values
Under IAS 37 – Provisions, Contingent Liabilities, and Contingent Assets, deciding whether to use the Most Likely Outcome or the Expected Value approach depends on the nature and complexity of the uncertainty involved.
When to Use the "Most Likely Outcome" Approach
This approach is appropriate when:
- The provision involves single, discrete outcomes.
- There are typically few possible outcomes.
- One outcome is clearly more probable than the others.
Example:
A company faces a legal claim with two possible outcomes:
- 70% chance of losing, resulting in a payment of £500,000.
- 30% chance of winning, resulting in no payment.
Provision calculation using Most Likely Outcome:
→ £500,000 (since this outcome is clearly the most probable).
When to Use the "Expected Value" Approach
The Expected Value approach is suitable when:
- The provision involves a large population of items or multiple potential outcomes.
- Outcomes span a range of possibilities, each with different probabilities.
- No single outcome dominates clearly.
Example:
A warranty obligation based on historical claims across thousands of units sold, with varying repair costs:
| Repair Cost per Unit | Probability | Calculation | Expected Amount |
|---|---|---|---|
| £100 | 30% | £100 × 30% | £30 |
| £150 | 50% | £150 × 50% | £75 |
| £200 | 20% | £200 × 20% | £40 |
| Total | 100% | Expected Cost/Unit | £145 |
If 1,000 units were sold, the provision calculation is:
→ £145 per unit × 1,000 units = £145,000
Quick Reference Table:
| Scenario | Appropriate Method | Reason |
|---|---|---|
| Limited outcomes; one clearly dominant result | Most Likely Outcome | Best reflects the most probable single outcome |
| Multiple outcomes or large populations with varying probabilities | Expected Value | Reflects weighted average considering all probabilities |
ACCA Exam Tips:
In ACCA examinations:
- If multiple outcomes and probabilities are provided, calculate using the Expected Value method.
- If there's a dominant probable outcome explicitly mentioned, use the Most Likely Outcome method.
- Always clearly state and justify your chosen approach according to IAS 37 criteria for full marks.
Conclusion:
Selecting between the Most Likely Outcome and Expected Value methods under IAS 37 is determined by the specifics of the provision scenario. Recognising this distinction is critical for accurate financial reporting and compliance with accounting standards.