Types of Provisions and Their FDD Treatment

Provisions are a recurring challenge in financial due diligence. They sit on the balance sheet as liabilities, but their nature, reliability, and economic substance vary enormously. Classifying and challenging provisions correctly is essential for an accurate net debt bridge and a credible working capital analysis.

What Is a Provision?

Under IAS 37, a provision is a liability of uncertain timing or amount. It is recognised when three conditions are met:

1. There is a present obligation (legal or constructive) as a result of a past event.
2. It is probable that an outflow of resources will be required to settle the obligation.
3. A reliable estimate can be made of the amount.

In practice, provisions range from well-supported, legally certain liabilities to management estimates with significant discretion baked in.

Common Types of Provisions

Litigation and Legal Provisions

Set aside to cover pending claims, regulatory investigations, or contractual disputes. These are among the most scrutinised items in FDD because:

• The quantum is inherently uncertain
• Management may understate to present a cleaner balance sheet
• The timeline for resolution may extend well beyond deal close

FDD treatment: legal provisions are typically included as debt-like items in the net debt bridge if they represent actual claims with quantifiable exposure.

Restructuring Provisions

Recognised when the company has a detailed formal plan and has raised a valid expectation in those affected. Restructuring provisions can be significant after acquisitions or operational reorganisations.

FDD treatment: verify that the plan is genuine, properly approved, and not inflated. Understand what costs are still to be incurred and confirm whether the provision is complete.

Warranty and Product Liability Provisions

Common in manufacturing, construction, and technology businesses. The company estimates the cost of honouring warranties on products already sold.

FDD treatment: test the provision against historical claims rates and revenue. If the warranty provision has been consistently under- or over-stated, there may be a EBITDA normalisation point.

Bad Debt and Credit Loss Provisions

Provisions against trade receivables for expected credit losses. Under IFRS 9, these follow an expected credit loss (ECL) model.

FDD treatment: part of working capital analysis. Test the provisioning policy against the ageing profile of debtors and the actual write-off history.

Onerous Contract Provisions

Recognised when the unavoidable costs of meeting a contractual obligation exceed the economic benefits expected. Common in long-term service contracts or supply agreements where pricing is locked in.

FDD treatment: understand the contract terms, the remaining period, and the basis for the estimate. These can represent significant liabilities in businesses with fixed-price long-term contracts.

Environmental and Decommissioning Provisions

Common in industries with regulated environmental obligations — oil and gas, chemicals, mining, waste management. Can be very large and subject to significant estimation uncertainty.

FDD treatment: typically treated as a debt-like item. The discount rate, cost assumptions, and timing should all be validated.

Key FDD Questions for Any Provision

• What is the triggering event, and has it already occurred?
• What is the basis of management's estimate, and has it been reviewed by an external adviser?
• How does the balance compare to historical utilisation of similar provisions?
• Is the provision being released to P&L in ways that flatter reported earnings?
• Where does the provision sit — within working capital or outside it?

Understanding balance sheet items like provisions is critical for both the net debt bridge and working capital analysis — two of the most tested topics in TS interviews. Our programme's 8+ case studies and 150+ EBITDA adjustments build that foundation systematically. One payment of €119.99.