Question

Urban ple, a company that prepares its financial statements to 31 December each year, is involved in the construction and repair of city centre student accommodation. Before the financial statements for the year ended 31 December 2018 can be finalised, a number of outstanding issues need to be resolved. Issue 1: In early January 2019, a customer commenced legal action against Urban plc alleging that construction work completed in September 2018 had not been carried out in accordance with the terms of the contract. The directors of Urban plc intend to defend the allegations vigorously and Urban ple's legal advisors estimate that the company has an 75% chance of successfully defending the claim. If the customer is successful, penalties and legal fees are expected to amount to £1,500,000. If Urban plc wins the case, non-recoverable legal fees of £65,000 will have been incurred. The directors of Urban ple are proposing to omit reference to the legal action in the financial statements for the year ended 31 December 2018 as the writ was not issued until January 2019. 4 Marks Issue 2: Urban ple was informed on 6 January 2019 that one of its major customers, Unibed Limited, had gone into liquidation The liquidator indicated that no payments would be made to unsecured creditors. The amount owed by Unibed Limited to Urban plc on 6 January 2019 amounted to £100,000, of which £60,000 related to work completed on 21 December 2018 and £40,000 to work commenced and completed during the first week of January 2019. 6 Marks Issue 3: During 2018, there was unrest amongst Urban ple's construction workers following changes to their terms and conditions of employment, with the directors of Urban plc seeking to make 20% of the workforce redundant. On 6 January 2019, following protracted negotiations, it was agreed that 12% of the workforce would be made redundant at a cost of £400.000

Answer 1

Case No 1 – Provision , Contingent asset and Contingent Liability : Legal cases against Urban Plc.In early January 2019, Customer commenced legal action against Urban Plc against the construction work completed in Sep. 2018 Urban Plc not carried out construction work as per Terms. Urban Plc legal advisor estimate that if the customer is successful , then penalties and legal fees are expected amount GBP 1,500,000. If urban Plc win the case non recoverable legal fees GBP 65000 will have been incurred . Urban Plc director are proposing Omit reference to the legal action in the financial statement – This is not acceptable . The above matter relates to 2018 construction . Management body of Urban Plc are well aware that they did not complete the work as per Terms and they might face legal issue in future . In this situation , they must disclose complete High Probable future legal matter on the basis of past events in the Audited Financial Statement under “ Provision , Contingent Asset and Contingent Liability as per GAAP.

Contingent Liability

As per GAAP, Contingent liability mean a possible obligation depending on some uncertain future events .   As per Question , it was mentioned that Legal advisor estimate that the Company has an 75% chances successfully defending the case . So As on Balance Sheet date , we are not clear about this transaction . This matter should be treated as contingent liability and provide complete details in Audited financial statement

Provision

Other part of expenses , which are Non recoverable in nature . Best to provide this amount in Financial Statement. This is definite a cash outgo from Companies account subject to occurrence in near future .

Issue 2: Urban Plc was informed 6^th Jan ’19 that one of its major customer   in to Liquidation . Urban Plc about to collect GBP 100,0000 of which GBP 60000 relates to work completed   as on 21^st Dec 2018 and balance amount relates to first week of Jan’19.

The above case is very common in nature for every business . As per Accounting standard IFRS 9 , Which is talking about ECL ( Expected Credit loss) concept in case of Trade receivable , Loan Commitment , Lease Liability etc under simplified approach .

As per ECL method , we need to look into nature of Trade receivable mainly collection visibility . If collection visibility zero and asset is 100% impaired . We need to design Provision Matrix to calculate expected credit loss amount . In this case , Customer is unable to pay any amount and assume that customer credit risk is very high and future collection possibility also no chance . As per Provision matrix ( basically Expected default rate as per ageing ) we need to make provision in the books .

Urban plc make tentative provision in the Financial on the basis of ECL method .

Make Additional Provision in the books

Issue 3 – Workforce redundant – Urban plc construction worker following changes to their terms and conditions of employment . So Management expect 20% of the workforce redundant . On the basis of this assumption , Company has to make additional Provision relates to 20% workforce redundant . In future , if number reduced as compared to provision amount , then company will reverse excess provision into financial .

Dividend Declare and Make additional provision

Issue 4- Companies Profit crossed expected expectation and the director wish to reward the Ordinary shareholders . At the meeting of the Board of Director it was decided to pay dividend GBP 500,000. This amount has to be paid immediately .

We assume that Company after making relevant provision ( as discussed issue 1 – 3) will be in a position to Good amount of Profit and company can declare good amount of dividend .

In the above scenario , we need to make Provision against Dividend Payable ( As per standard , whenever dividend amount declared , we need to make additional provision in books of account ) .