ACCA Audit and Assurance (F8) Practice Exam

Which statement accurately distinguishes between a provision and a contingency?

1. A provision is recorded in the current period while a contingency is never recognized

2. A provision is a definite liability while a contingency is not

3. A provision is optional while a contingency is mandatory

4. A provision is an expense while a contingency is considered income

The correct answer is: A provision is a definite liability while a contingency is not

The distinction between a provision and a contingency is crucial in financial reporting, particularly in the context of liabilities. A provision is recognized in the financial statements when an entity has a present obligation (legal or constructive) as a result of a past event, and it is probable that an outflow of resources will be required to settle that obligation. Additionally, the amount of the obligation can be reliably estimated. In contrast, a contingency arises from a past event but does not meet the criteria for recognition as a provision. It refers to a potential obligation that may occur depending on the outcome of a future event, like litigation or uncertain outcomes. As a result, contingencies are not recognized in the financial statements but are disclosed in the notes if the possibility of an outflow of resources is more than remote. Therefore, it is correct to state that a provision is a definite liability, as it is recognized and recorded in the accounts, reflecting a real obligation, while a contingency represents a potential liability that lacks the certainty necessary for recognition. This clear distinction helps entities manage their financial statements in accordance with applicable accounting standards.