Litigation Reserve

A company faces a supplier claim at year-end. It works with legal and finance teams to assess whether an obligation from a past event exists, whether an outflow is probable and whether a reliable amount can be estimated, and the accounting depends on the evidence, not the size of the demand letter alone.

IAS 37 defines a provision as a liability with uncertain timing or amount and sets recognition criteria for present obligation, probable outflow and reliable estimate, while distinguishing contingent liabilities that are not recognised as provisions. The IFRS standard describes measuring a provision at the best estimate of the expenditure required to settle the present obligation.

This is not necessarily the claimant's requested amount or a worst-case figure. Counsel may identify plausible settlement outcomes and timing, and finance must apply the framework measurement rules rather than automatically choosing the highest number.

Determine the reporting framework first, because IFRS and US GAAP use their own rules and terminology and a company should not mix thresholds or disclosure requirements from different frameworks. Then identify the underlying past event, since a threatened claim can involve a genuine pre-existing obligation, a merely possible one or no obligation.

Assess probability at the reporting date; subsequent evidence may clarify conditions that already existed, but a later unrelated event can have different accounting treatment. Document assumptions, including case facts, legal advice, comparable outcomes and expected settlement costs, while handling legal privilege and disclosure carefully.

A large population of similar matters can be measured differently from one individual case, so do not use a simple average blindly. Track cases individually with a matter ID, counsel assessment, reporting date, amount, status and approval, because a single aggregate number can hide changes.

Reassess every reporting period, since new evidence, negotiations or court developments can change probability and amount. Distinguish a provision from a cash earmark, because recognising a liability does not necessarily mean segregating cash in a bank account.

A possible reimbursement from an insurer is not automatically netted against the provision, and some legal costs may be included or excluded depending on the nature of the obligation and accounting policy. An illustrative entry for a qualifying $100,000 provision is debit expense $100,000 and credit provision liability $100,000, subject to applicable accounting assessment.

A contingent liability may require note disclosure even if no provision is recognised, and material assumptions should be available to auditors without treating auditor inquiry as a substitute for management judgment. Avoid creating a cushion, because provisions are not a general reserve for unspecified bad news, and when the obligation changes or ends the provision should be reversed or adjusted under the framework.