What are Provisions?
Provisions are the present obligation (probability of occurrence is more than 51%) arising out of past events. Provision can be made by retaining the amount by way of providing for any known liability, the amount of which can not be determined accurately. It is a liability that can be measured only by using a substantial degree of estimation. It is an amount kept aside to cover the expenses that may occur in the future.
Example: As per the estimations, a firm believes that 20% of their Debtors may not pay their dues. So, the firm can make a provision for bad debts in the books to cover them.
It is shown as a current liability on the liabilities side of the balance sheet and recorded as expenses in the income statement. Provisions are tax-deductible expenses, which means that while calculating profit before tax (PBT), it should be taken as an expense. While making cash flows, provisions should not be taken as there is no cash outflow/inflow. Examples of provisions are Provision for Depreciation, Provision for Doubtful Debts, Provision for Taxation, Provision for repairs, etc.
Difference between Provisions and Reserves
Preparation of Accounts in business firms is done by following the ‘Going Concern Concept’, which states that the firm will continue for a long period of time irrespective of everything. Keeping an eye on this, the profit of the firm is allocated in such a way that some amount of profit is kept for current and future contingencies. Provisions and Reserves are related to future needs of the business for which a part of the current year’s profit is set aside. There are some similarities, but both have their different purposes, tax treatment, and needs for a business. Both are very important for a business and have their own role to play in accounting.