Current Liabilities Provisionand Contingencies Materials and Assignments [PDF]

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A contingent asset is “[a] possible asset that arises from past events and whose existence will be confirmed only b occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity” [IAS 37 para 10].

A contingent asset is “[a] possible asset that arises from past events and whose existence will be confirmed only b occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity” [IAS 37 para 10].

IAS 37 does not permit the recognition of contingent assets. Contingent assets are disclosed only when an inflow benefits is probable. This is different from contingent liabilities, where disclosure is required unless an outflow is re para 31]. [IAS 37 para 34].

A contingent asset is not recognised, because it might result in the recognition of income that is never realised. Wh virtually certain that an inflow of economic benefits will arise, the asset is no longer a contingent asset and should in the period in which the change occurs (that is, when the future event occurs and confirms the asset’s existence, becomes virtually certain that the future event will confirm the asset’s existence and it is virtually certain that the a realised).

Contingent liabilities arise where there is a: - possible obligation as a result of a past event that might, but will probably not, require an outflow of resources em economic benefits; or - present obligation as a result of a past event: - that probably requires an outflow of resources embodying economic benefits, but where the obligation cannot be reliably; or - that might, but will probably not, require an outflow of resources embodying economic benefits. [IAS 37 para 10].

A contingent liability should not be recognised. It should be disclosed, unless the possibility of an outflow is remote [IAS 37 para 27]. [IAS 37 para 28]

Warranties

Manufacturers offer warranties on their products. A warranty is a guarantee or promise about the quality or performance of

From an accounting perspective, warranties entail future costs. When a product is sold, the seller recognizes revenue in the c recognized in a period, all expenses associated with those revenues must also be recognized in that period. Hence, warranty the actual amount of the expenses is not known -- the actual warranty-related expenses will be incurred in the future.

Under accrual accounting, two methods are used to account for warranties. The expense warranty method is used when the the company charges one single sales price that covers the product and its warranty.

The expense warranty method estimates future (contingent) expenses associated with the warranty for the product sold. Th credited to the Estimated Liability for Warranty account. In subsequent periods, when actual expenses are incurred to repair and various accounts (such as Inventory, Wages Payable) are credited.

Some companies charge a sales price that includes a basic warranty and then offer a separate warranty contract for an exten month warranty. The buyer has the option to purchase an extended warranty for $99. In this example, the extended warrant method is used. This method records the amount received under the extended warranty in the Unearned Revenue account. revenue each period.

Premiums and Coupons

A premium is a company's offer to exchange items such as toys and small appliances for a proof-of-purchase (POP) label or w manufacturer offers a toy to customers who send three proofs-of-purchase from cereal boxes. Companies offer coupons that give a cash discount at the time of purchase or a cash rebate after purchase.

Companies use premiums and coupons to increase the sales of their products. The expenses associated with premiums and the associated sales are made. This is because of the matching principle.

All premiums and coupons redeemed during a period are recognized in that period. Some premiums and coupons from curr example, if customers purchase cereal boxes in the last week of December, they may wait until the boxes are empty before s in January. Thus, a contingent liability must be created for premiums and coupons offered in the current period that are exp

In addition, some customers wait for some time before redeeming the premiums or coupons. Other customers do not use th coupons is usually less than 100 percent. The expected redemption must be made estimated.

ence will be confirmed only by the thin the control of the entity”.

ence will be confirmed only by the thin the control of the entity”.

sclosed only when an inflow of economic equired unless an outflow is remote. [IAS 37

ome that is never realised. When it becomes contingent asset and should be recognised onfirms the asset’s existence, or when it it is virtually certain that the asset will be

ire an outflow of resources embodying

where the obligation cannot be measured

mic benefits.

sibility of an outflow is remote.

ut the quality or performance of a product, usually for a specified period of time.

seller recognizes revenue in the current period. Under the matching principle, if some revenue is in that period. Hence, warranty expenses must be recognized in the period of sale even though be incurred in the future.

rranty method is used when the item sold and the warranty are considered inseparable. That is,

warranty for the product sold. This amount is debited to the Warranty Expense account and expenses are incurred to repair the product, the Estimated Liability account is debited and Cash

e warranty contract for an extended period. Thus, a CD system sells for $299 with a basic one example, the extended warranty is sold separately. In such instances, the sales warranty he Unearned Revenue account. As time goes by, a part of the unearned revenue is recognized as

roof-of-purchase (POP) label or wrapper from one or more products. For example, a cereal es.

after purchase.

s associated with premiums and coupons must be recognized as expenses in the period in which

remiums and coupons from current period sales may not be redeemed in this period. For ntil the boxes are empty before sending in the proof-of-purchase to the manufacturer sometime n the current period that are expected to be redeemed in the future.

s. Other customers do not use them at all. In other words, the redemption rate on premiums and d.

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Example 1: Provisions in various situations

IAS 37: Provisions

1. Warranties CarProd is a car manufacturer who gives warranties to its clients at the time of purchase. Under the terms of sale contract, CarProd undertakes to repair manufacturing defects or replace defective parts that become apparent within 5 years from the date of sale. Based on previous experience, it is probable that there will be some claims under warranties. Should CarProd recognize any provision?

Assessment Present obligation as a result of past event? Outflow of economic benefits probable? Reliable estimate?

2. Contaminated land A. Legislation to be enacted PhthalateCorp operating in chemical industry worldwide regularly causes contamination of land , but cleans up only when is required so under the laws of particular country. Country Cleanlandia has had no such legislation and PhthalateCorp has been contaminating land for several years. As at 31 December 20X1 it is certain that draft of law requiring clean-up of contaminated land (no matter when) will be enacted after the year-end in Cleanlandia. Should PhthalateCorp recognize any provision?

Assessment Present obligation as a result of past event? Outflow of economic benefits probable? Reliable estimate?

2. Contaminated land B. Constructive obligation BenzCorp operating in chemical industry worldwide regularly causes contamination of land , but has widely published its environmental policy in which it undertakes to clean up all contamination. Benz Corp operates also in the countries without any environmental legislation. Should BenzCorp recognize any provision for clean-up of land also in countries without applicable laws?

Assessment Present obligation as a result of past event? Outflow of economic benefits probable? Reliable estimate?

3. Refunds policy Tracy's Co, home appliances retailer, has a generally known policy of refunding purchases by unhappy customers even though it is not required by law. Should Tracy's recognize any provisions for refunds?

Assessment Present obligation as a result of past event? Outflow of economic benefits probable? Reliable estimate?

4. Legal requirement to fit smoke filters Under new legislation, PaperCo is required to fit smoke filters to its factories by 31 March 20X2. Paper Co has not fitted smoke filters yet. Should PaperCo recognize any provision as at 31 December 20X1 and 20X2?

Present obligation as a result of past event?

31-Dec-20X1 no

31-Dec-20X2 not for costs of filters, but yes for penalties

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Example 1: Provisions in various situations

Outflow of economic benefits probable?

n/a

depends on details of law and stringency of enforcement regime

Reliable estimate?

n/a

yes for penalty

No provision

IAS 37: Provisions

Recognize provision (best estimate of the penalty)

5. Repairs and maintenance SkyBeings, an airline, needs to replace seats in its aircraft every 5 years. At the end of 20X1, the seats have been in use for 3 years. Also, SkyBeings is required by law to overhaul its aircraft once every 3 years. Should SkyBeings recognize provision for replacement of seats or overhauling as at 31 December 20X1?

Seats no

Overhauling no

Outflow of economic benefits probable?

n/a

n/a

Reliable estimate?

n/a

n/a

No provision

No provision

Present obligation as a result of past event?

6. Staff retraining Government introduces a number of changes to the income tax system. As a result of these changes, Taxexperts Co will need to retrain a large number of its financial services staff in order to continue providing up-to-date information and advices to its clients. Should Taxexperts recognize provision for retraining?

Present obligation as a result of past event?

Assessment no

Outflow of economic benefits probable?

n/a

Reliable estimate?

n/a

No provision

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Example 2: Contingent liabilities and contingent assets

IAS 37: Provisions

HamburgerPrince, fast food company, organized birthday party for 20 children where burgers from minced beef meat were served. After the party, 8 children came to hospital suffering from food poisoning and their parents believe that it is due to burgers not fried properly. Parents are now suing HamburgerPrince. Lawyer of this company believes that based on past similar court cases and insufficient evidence against HamburgerPrince there is 40% chance of losing the case and HamburgerPrice would have to pay 160 000 EUR to indemnify children for poisoning. What should HamburgerPrince do in its financial statements in relation to this claim?

Assessment Present obligation as a result of past event? Outflow of economic benefits probable? Reliable estimate?

A few months later, court case proceeded further where one employee of HamburgerPrince , acting as a witness, stated that frozen beef burgers supplied by local meat processing company Beefers showed signs of potential bacterial infection. Judge ordered immediate inspection in Beefers to verify its' hygienic and work standards. Inspection proved presence of several bacteria in half products. Court case against HamburgerPrince has not been closed yet. Based on this new evidence, lawyer believes that chance to lose the case increased to 80% . HamburgerPrince then decided to sue Beefers for supplying contaminated burgers and causing them damage. However, Beefers argue that if HamburgerPrince would have fried burgers properly, every possible infection would be destroyed. Lawyer believes that HamburgerPrince has 90% chance of winning this case with compensation of 160 000 EUR from Beefers. What should HamburgerPrince do in its financial statements in relation to new events?

1. HamburgerPrince vs. parents

Present obligation as a result of past event? Outflow of economic benefits probable? Reliable estimate?

2. HamburgerPrince vs. Beefers

Possible asset as a result of past event? Inflow of economic benefits virtually certain? Reliable estimate?

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Example 3: Measurement of and accounting for provisions

IAS 37: Provisions

CarProd ,car manufacturer, undertakes to repair manufacturing defects or replace defective parts that become apparent within 5 years from the date of sale. Past experience and future expectations indicate the following: 1. Repair costs depend on the extent of defects: 400 mil. EUR in case of minor defects and 700 mil. EUR in case of major defects (if all cars would have minor / major defects). 2. CarProd estimates 80% cars with no defects, 18% cars with minor defects and 2% cars with major defects were sold in the year 20X1. 3. 10% of all repairs is made in the 1st year after sale, 15% in the 2nd year, 20% in the 3rd year, 25% in the 4th year and 30% in the 5th year. These figures relate to both major and minor repairs. All cash flows happen at the end of year. 4. Pre-tax current market rate is 3% p.a. What should CarProd disclose in its financial statements as at 31 December 20X1?

1. Assessment of provision

Present obligation as a result of past event? Outflow of economic benefits probable? Reliable estimate?

Exercise 1 - Provisions and Contingent Liabilities

Which one of the following correctly describes the circumstances in which an obligation should be recognized as a liabilit financial statements? The chance of the future event occurring is remote. The chance of the future event occurring is possible. The chance of the future event occurring is probable, but the amount is not estimable. The chance of the future event occurring is slight. The chance of the future event occurring is more likely than not, and the amount can be measured reliably.

Exercise 2 - Provisions and Contingent Liabilities

Rayn Company is involved in the following legal matters: A customer is suing Rayn for allegedly selling a faulty and dangerous product. Rayn’s attorneys believe that there is a 40% Rayn’s losing the suit.

A federal agency has accused Rayn of violating numerous employee safety laws. The company faces significant fines if fo Rayn’s attorneys feel that the company has complied with all applicable laws, and they therefore place the probability of fines at less than 10%.

Rayn has been named in a gender discrimination lawsuit. In the past, Rayn has systematically promoted its male employ rate than it has promoted its female employees. Rayn’s attorneys judge the probability that Rayn will lose this lawsuit at For each item, determine the appropriate accounting treatment.

Exercise 4 - Distinguishing the accounting for contingent liabilities

The following legal claims exist for Kumamon Co. Identify the accounting treatment for each claims as either (a) a liabili recorded or (b) an item described in notes to its financial statements.

1. Kumamon (defendant) estimates that a pending lawsuit could result in damages of $2,500,000; it is possible that plai case. 2. Kumamon faces a probable loss on a pending lawsuit; the amount is not reliably estimate. 3. Kumamon estimates damages in a case at $4,000,000 with a high probability of losing the case.

Exercise 5 - Warranty

Quick Manufacturing Co. warrants its products for one year. The estimated product warranty is 10% of sales. The sales w NT$770,000 for April. In September, the actual warranty repair costs were NT$45,000. Prepare the entry to record the accrued product warranty at April 30. Journalize the entry to record the warranty cost in September.

Exercise 6 - Computing Warranty Expense

ASEN Computer Co. warrants its products for one year. The estimated product warranty is 5% of sales. Assume that the NT$1,000,000 for January. On February 5, a customer received warranty repairs requiring NT$4,250 of parts and of NT$ Prepare the adjusting entry required at January 31 to record the accrued product warranty. Prepare the journal entries to record the warranty work provided in February.

Exercise 6 - Computing Warranty Expense

ASEN Computer Co. warrants its products for one year. The estimated product warranty is 5% of sales. Assume that the NT$1,000,000 for January. On February 5, a customer received warranty repairs requiring NT$4,250 of parts and of NT$ Prepare the adjusting entry required at January 31 to record the accrued product warranty. Prepare the journal entries to record the warranty work provided in February.

Exercise 7 - Coupons and Premiums

Healthy Cereals sells organic cereals and began a promotion on November 1, 2002. It offered a premium of a special gla exchange for two proofs-of-purchase from its cereal boxes and $2. The company purchases the glass bowls from a supp and expects a redemption rate of 80 percent. During the period ending December 31, 2002, the company sold 2,000 ce received back 1,200 proofs-of-purchase from its customers. Determine the premium expense for the period.

Exercise 8 - Coupons and Premiums

Fayanna's Company included one coupon in each package sold. A premium is offered to customers who send in 10 coup

Number of packages sold Number of premiums purchased @ P40 each Number of premiums distributed Number of premiums to be distributed next period

2019 500,000 30,000 20,000 5,000

2020 800,000 60,000 50,000 3,000

1. What amount should be reported as premium expense for 2019? 2. What amount should be reported as estimated premium liability on December 31, 2019? 3. What amount should be reported as premium expense in 2020? 4. What amount should be reported as estimated premium liability on Deceber 31, 2020?

be recognized as a liability in the

red reliably.

believe that there is a 40% chance of

faces significant fines if found guilty. re place the probability of incurring the

romoted its male employees at a faster yn will lose this lawsuit at more than 90%.

aims as either (a) a liability that is

000; it is possible that plaintiff will win the

ase.

s 10% of sales. The sales were

of sales. Assume that the sales were 4,250 of parts and of NT$2,750 of labor.

of sales. Assume that the sales were 4,250 of parts and of NT$2,750 of labor.

premium of a special glass bowl in e glass bowls from a supplier for $3 each e company sold 2,000 cereal boxes and

mers who send in 10 coupon

On December 31, 2019, Laelyn's Company purchased a machine from Helix Company in exchange for a non-interest bearing The first payment was made on December 31, 2019 and the others are due annually on December 31. At date of issuance, the prevailing rate of interest for this type of note was 11%. The PV of an ordinary annuity of 1 at 11% for 8 period is 5.146 The PV of an annuity of 1 in advance at 11% for 8 period is 5.712 1. On December 31, 2019, What is the Carrying Value of the Note Payable? 2. What amount should be recorded as interest expense for 2020

ge for a non-interest bearing note requiring eight payments of PhP 200,000.

ber 31.