Question

Question 3 Tee Ltd's directors decided on 3 May 2020 to restructure the company's operations as follows. • Factory Z would be closed down and put on the market for sale. • 100 employees working in Factory Z would be retrenched on 31 May 2020, and would be paid their accumulated entitlements plus 3 months wages. • The remaining 20 employees working in Factory Z would be transferred to Factory X, which would continue operating. • Five head-office staff would be retrenched on 30 June 2020, and would be paid their accumulated entitlements plus 3 months wages. As at the end of Tee Ltd's reporting period, 30 June 2020, the following transact had occurred. • Factory Z was shut down on 31 May 2020. An offer of $4 million had been received for Factory Z but there was no binding sales agreement. • The 100 retrenched employees had left and their accumulated entitlements had been paid. However, an amount of $76 000, representing a portion of the 3 months wages for the retrenched employees, had still not been paid. • Costs of $23 000 were expected to be incurred in transferring the 20 employees to their new work in Factory X. The transfer is planned for 14 July 2020. • Four of the five head-office staff who have been retrenched have had their accumulated entitlements paid, including the 3 months wages. However, one employee, James Perry, remains in order to complete administrative tasks relating to the closure of Factory Z and the transfer of staff to Factory X. Jerry is expected to stay until 31 July 2020. His salary for July will be $4000 and his retrenchment package will be $13 000, all of which will be paid on the day he leaves. He estimates that he would spend 60% of his time administering the closure of Factory Z, 30% on administering the transfer of staff to Factory X, and the remaining 10% on general administration. Required Calculate the amount of the restructuring provision recognised in Tee Ltd's financial statements as at 30 June 2020, in accordance with AASB 137.

Answer 1

1.

As per AASB 137 and IAS 37 “Provision is a liability of uncertain timing or amount”. Liability is a present obligation arising from past events, the settlement of which will result in outflow of economic resources. Provision is a liability because there is a present obligation but the amount and time of settlement is not yet known.

A provision shall be recognized only if the following conditions are met:

1. an entity has a present obligation (legal or constructive) as a result of a past event;

2. it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and

3. a reliable estimate can be made of the amount of the obligation.

According to AASB 137 “A contingent liability is

(a) a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity; or

(b) a present obligation that arises from past events but is not recognised because: (i) it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or (ii) the amount of the obligation cannot be measured with sufficient reliability.

Contingent liabilities are not recognized in the financial statements as they are either (i) possible obligations or (ii) a present obligations that do not meet the recognition criteria.

Provision must be created againt this liability

3 months wages for retrenched employees $76000

If the provision is created, it will certainly increase the gearing ratio, as the provision is treated as a long term liability. increase in gearing ratio will be an indiactor of increased risk. Prospective investors will not take up the risk and they will ove away.