You Owe It, You Just Don't Know the Exact Bill
A provision is a liability where you are confident you owe something, but you are not sure exactly how much or exactly when you will pay it.
That is the whole idea. FRS 102, the standard most UK private companies follow, defines a provision as "a liability of uncertain timing or amount". IAS 37 uses the same words. A supplier invoice for £2,400 is not a provision, because you know the amount and the due date. The cost of putting a leased warehouse back to its original state when the lease ends in three years is a provision, because the obligation is real but the figure is an estimate.
Booking a provision does two things at once. It puts the liability on the balance sheet, and it charges the cost to the profit and loss account in the year the obligation arose, not the year the cash goes out.
This guide covers when you are allowed to book one, the journals, how a provision differs from an accrual and a reserve, a worked example, and when HMRC gives tax relief. It also covers the provisions we see directors ask for that the rules do not allow.
Two Meanings of the Word "Provision"
Before going further, it is worth clearing up the confusion behind a lot of searches for this term. Accountants use "provision" for two different things.
- A liability provision. Money you expect to pay out, such as a legal claim, a dilapidations bill or warranty repairs. This sits in liabilities. It is what FRS 102 Section 21 and IAS 37 mean by a provision, and it is the main subject of this guide.
- An asset write down that is still called a provision. A "provision for doubtful debts" or a "provision for slow moving stock" is not a liability at all. It reduces the value of an asset. The rules for these sit in different parts of the standards. We cover the first one in detail in our guide to bad debts, and stock write downs come up in our guide to stock turnover.
There is a third use that trips up students reading American material. In US accounts, "provision for income taxes" simply means the tax charge for the year in the P&L. In UK accounts, corporation tax you owe for the year is a normal creditor, shown in current liabilities, not a provision. The tax that does appear under provisions in UK accounts is deferred tax.
When Can You Book a Provision?
FRS 102 Section 21 sets three tests. All three must be met at the balance sheet date.
- A present obligation from a past event. Something has already happened that leaves the company with little or no realistic choice but to pay.
- A probable outflow. It is more likely than not that the company will have to pay out cash or other resources.
- A reliable estimate. You can put a sensible figure on it. The standard expects that you nearly always can, even if the figure is a range.
If any test fails, there is no provision. You then ask whether the item is a contingent liability that needs a note in the accounts, which we cover in our guide to contingent liabilities.
Legal and constructive obligations
The first test is where most of the judgement sits. An obligation can be:
- Legal, coming from a contract, legislation or a court ruling. A lease clause requiring you to repair the premises at the end is a legal obligation.
- Constructive, coming from how the company behaves. If you have a published returns policy that is more generous than the law requires, or you have always refunded customers in a certain situation, customers now expect it. That expectation creates an obligation even though no contract forces you to pay.
The point that catches people out is the word "past". The event has to have happened already. A future plan, however firm, does not count. If you intend to refit the shop next year, there is no obligation today, because you could simply change your mind.
Common Examples of Provisions
These are the provisions we see most often in small and medium sized UK companies.
- Dilapidations. Most commercial leases require the tenant to hand the property back in good repair and remove any alterations. The obligation builds up as the property wears and as you make changes, so it should be provided for over the life of the lease, not all in the final year.
- Onerous contracts. A contract becomes onerous when the unavoidable cost of meeting it is more than the benefit you will get from it. The textbook case is a lease on premises you no longer use. You provide for the net loss.
- Warranties. If you sell goods or services with a warranty, past experience usually tells you some proportion will need fixing. You provide for the expected cost across the whole class of sales.
- Legal claims and tribunal cases that your solicitor thinks you will probably lose.
- Refunds under a published policy. A constructive obligation, as explained above.
- Restructuring. Only once a detailed formal plan exists and the company has started it or announced it to the people affected. A board discussion is not enough.
- Deferred tax, which has its own rules but appears under the same balance sheet heading.
Provision vs Accrual vs Reserve
This is the comparison most people are really looking for. The three are often mixed up, and the difference matters for tax and for dividends.
| What it is | Where it sits | Certainty | |
|---|---|---|---|
| Accrual | A cost for goods or services already received but not yet invoiced | Creditors (current liabilities) | Amount and timing known or close to it |
| Provision | A present obligation of uncertain timing or amount | "Provisions for liabilities" on the balance sheet | Probable, estimated |
| Contingent liability | A possible obligation, or one that is not probable | Notes only, nothing on the balance sheet | Possible, not probable |
| Reserve | Part of shareholders' equity, such as retained earnings | Capital and reserves | Not a liability at all |
An accrual is the closest relative. The electricity used in March but billed in April is an accrual: the supply has happened and you can read the meter. The line between the two is about how much uncertainty is left. Our guide to accruals and prepayments covers the everyday cases.
A reserve is a completely different animal. It is part of what the company owes its shareholders, not what it owes anyone else. Older textbooks talk about "setting aside a reserve for future repairs" and that language still leaks into board minutes. If a company wants to earmark profits for a future project, it can do that in its own planning, but it does not create a liability and it does not reduce profit. More on that in retained earnings.
Where Provisions Appear in the Accounts
In the standard Companies Act balance sheet format, provisions have their own heading, "Provisions for liabilities", below creditors and above net assets. It is split between pensions, taxation including deferred tax, and other provisions.
Provisions are not split between current and non current in that format. If you are calculating ratios like the current ratio for a lender, check whether part of a provision is due within the next twelve months, because some lenders will want it counted.
Larger companies following full FRS 102 disclose a reconciliation for each class of provision: the opening balance, amounts added, amounts used, amounts released unused, any unwinding of discount, and the closing balance. Small companies using Section 1A have lighter disclosure duties, and micro-entity accounts show only the single headline figure. Even so, we keep that reconciliation in the working papers for every client. It is the first thing HMRC asks for if it queries a provision.
Provision Journal Entries
There are four movements to know. Each one uses double entry bookkeeping in the normal way.
1. Creating or increasing a provision
| Account | Debit | Credit |
|---|---|---|
| Expense in the P&L (for example, property repairs) | £9,000 | |
| Provision for liabilities (balance sheet) | £9,000 |
2. Using the provision when you pay
| Account | Debit | Credit |
|---|---|---|
| Provision for liabilities | £24,000 | |
| Bank | £24,000 |
Nothing hits the P&L at this point, because the cost was charged when the provision was made. If the final bill is higher than the provision, the extra goes to the P&L when it is known.
3. Releasing a provision you no longer need
| Account | Debit | Credit |
|---|---|---|
| Provision for liabilities | £5,000 | |
| The same P&L expense line used originally | £5,000 |
Release it to the line it was charged to, not to "other income". Otherwise one year's expenses look too high and the next year's income looks oddly good.
4. Unwinding the discount
Where the payment is several years away and the time value of money is material, FRS 102 requires the provision to be measured at present value. Each year the discount unwinds and the provision grows towards the final amount. The increase is charged as a finance cost, not as an operating expense.
A provision can only be used for the cost it was set up for. You cannot quietly use a dilapidations provision to absorb a bad debt.
Worked Example: Fernhill Print Ltd
Fernhill Print Ltd is a commercial printer in Leicester with a 31 December year end, turnover of £2.1 million and taxable profits comfortably above £250,000. At 31 December 2026 the directors and their accountant review five items.
1. Dilapidations on the main unit. Fernhill has a ten year lease ending in 2029. The lease requires the unit to be returned in its original condition. A surveyor estimates the wear and tear built up so far will cost £24,000 to put right. Last year's accounts provided £15,000. Treatment: increase the provision by £9,000. With only three years to run, the directors judged the discounting effect immaterial and did not discount.
Fernhill also installed a mezzanine floor in 2024 that the lease says must be removed at the end. The surveyor puts removal at £18,000. That obligation arose the moment the mezzanine went in. Treatment: a provision of £18,000, added to the cost of the mezzanine as a fixed asset and depreciated over the remaining lease, rather than charged straight to the P&L.
2. An empty second unit. Fernhill moved its finishing work back to the main site in October and the small second unit now sits empty. The lease has 18 months left at £1,500 a month, a total of £27,000. A local business has agreed to sublet it for £600 a month. Treatment: an onerous contract provision of £16,200 (£27,000 less £10,800 of subletting income).
3. A "repairs provision" for the press. The managing director wants to book £30,000 for a major overhaul of the main press, due in 2027. Nothing in law or contract obliges the company to overhaul it, and the directors could sell the press instead. Treatment: no provision. There is no present obligation.
4. Closing the binding department. The board has discussed closing a small binding department in 2027. No plan has been drawn up and staff have not been told. Treatment: no provision. A restructuring provision needs a detailed plan and a valid expectation in those affected.
5. Reprint guarantee. Fernhill's website promises a free reprint for any order with a print fault reported within 30 days. Historically, reprints cost about 0.8% of sales. December sales were £180,000. Treatment: a provision of £1,440, because the published promise is a constructive obligation.
| Item | Treatment | P&L charge for 2026 |
|---|---|---|
| Dilapidations (wear and tear) | Increase provision | £9,000 |
| Mezzanine removal | Provision, capitalised into asset cost | Depreciation only |
| Empty second unit | Onerous contract provision | £16,200 |
| Press overhaul | No provision | £0 |
| Binding department closure | No provision | £0 |
| Reprint guarantee | Provision | £1,440 |
| Total | £26,640 |
The press overhaul is the one that caused the argument. The director's reasoning was that the money will definitely be spent, so why not show it now? The answer is that the company still controls that decision. If Fernhill wins a big contract and decides to replace the press instead, the overhaul never happens. A provision would have moved profit from 2026 into 2027 for a cost that might not exist.
Are Provisions Tax Deductible?
Often, yes, but not automatically.
HMRC's Business Income Manual at BIM46510 sets out when a provision is allowable for corporation tax. In summary, the provision must:
- relate to revenue expenditure, not capital,
- be made in accordance with generally accepted accounting practice,
- not be overridden by a specific statutory rule, and
- be estimated with sufficient accuracy.
For Fernhill, the £9,000 dilapidations increase for wear and tear, the £16,200 onerous lease and the £1,440 reprint provision are all revenue in nature and follow FRS 102, so they are deductible in 2026. At the 25% main rate of corporation tax, that is a saving of £6,660 this year. You can model the effect on your own figures with our corporation tax calculator.
The mezzanine removal provision is different. It relates to a capital asset, so it gets no relief through the P&L, and the depreciation on it is added back in the tax computation like any other depreciation.
Two court cases show how the tax and accounting rules fit together. In Herbert Smith v Honour (1999), a law firm was allowed tax relief for a provision for future rent on premises it had vacated, because the provision followed proper accounting practice. That is the same type of onerous lease provision Fernhill has made. In Johnston v Britannia Airways (1994), an airline was allowed a provision for future engine overhauls. That case was decided under older accounting rules. Under FRS 102, a provision for future maintenance of an asset you own normally fails the present obligation test, so it would not be in the accounts in the first place, and without GAAP compliance there is no tax deduction.
Some provisions are overridden by statute. The main one we see is staff pay. Bonuses and other employee remuneration provided for at the year end are only deductible if they are paid within nine months of the year end, under section 1288 of the Corporation Tax Act 2009. Otherwise relief waits until the year they are paid.
Our View
The provisions people ask for are the ones the rules forbid. In our experience, directors rarely forget a provision for something like a tribunal claim. What they ask for is a provision to smooth profits: a repairs fund, a "rainy day" amount, a cushion against a bad year. FRS 102 was written specifically to stop this. If you want to set money aside for a known future project, do it in your management accounts and your cash planning, not in the statutory accounts.
Dilapidations are the one most small businesses miss. We regularly take on clients in year eight of a ten year lease with nothing provided at all. Then the landlord's surveyor sends a schedule for £40,000 and the whole cost lands in one year. That year's profit takes the full hit, which can upset bank covenants and a planned dividend. Get a rough estimate from a surveyor early in the lease and build the provision up each year. It also gives you something to negotiate with when the landlord's schedule arrives.
Provisions affect what you can pay out. A provision reduces retained earnings, and dividends can only be paid out of accumulated realised profits under section 830 of the Companies Act 2006. If you are planning a large dividend near the year end, get the provisions reviewed first. Finding a £25,000 dilapidations liability after the money has gone is a far harder conversation.
Revisit every provision every year. A provision is an estimate, and estimates go stale. If the onerous lease gets assigned, release the provision. If the surveyor's figure goes up, increase it. A provision that sits unchanged on the balance sheet for five years is usually wrong in one direction or the other, and HMRC notices round figures that never move.
Write down your working. A one page note per provision, showing where the number came from, is enough for most small companies. A surveyor's letter, a solicitor's email, a spreadsheet of past warranty claims. If HMRC opens an enquiry, the question is always "how did you arrive at this figure?" and a good answer usually ends the discussion.
How IAK Can Help
Our accounting team prepares year end accounts under FRS 102 and FRS 105, including provisions backed by proper working papers, so the figures hold up if they are ever questioned.
Our tax planning team checks each provision for corporation tax deductibility and handles the add backs for capital items and unpaid remuneration. Our management reporting service keeps leases, claims and warranty costs in view through the year, so provisions are built up steadily rather than discovered at the year end.
We work with limited companies and small businesses across the UK. If you have a lease coming to an end, an empty unit or a claim against the company and want to know how it should show in your accounts, get in touch for a free consultation.
Sources
- FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland, Financial Reporting Council, Section 21 Provisions and Contingencies.
- IAS 37 Provisions, Contingent Liabilities and Contingent Assets, IFRS Foundation, the international standard on which Section 21 is based.
- Technical factsheet: Provisions and contingencies, ACCA, a practical summary of recognition and measurement.
- Business Income Manual BIM46510, HMRC, on when provisions are allowable for tax.
- Corporation Tax Act 2009, section 1288, legislation.gov.uk, on the nine month rule for unpaid employee remuneration.
- Companies Act 2006, section 830, legislation.gov.uk, on distributions only being made out of profits available for the purpose.