Question

Below are three independent situations.

1.   In August, 2011 a worker was injured in the factory in an accident partially the result of his own negligence. The worker has sued his employer, Simon Corp, for $800,000. Simon’s legal counsel believes it is possible that the outcome of the suit will be unfavourable and that the settlement would cost the company from $250,000 to $500,000.

     

2.   A suit for breach of contract seeking damages of $1,200,000 was filed by an author against Eller Co. on October 4, 2011. Eller's legal counsel believes that an unfavourable outcome is more likely than not. A reasonable estimate of the award to the plaintiff is between $300,000 and $900,000. No amount within this range is a better estimate of potential damages than any other amount.

     

3.   Pratt is involved in a pending court case. Pratt's lawyers believe it is likely that Pratt will be awarded damages of $1,500,000.

     

Required:

For each independent situation above, discuss the proper accounting treatment, including any required disclosures for the situation. Give the rationale for your answers. Assume all companies involved use IFRS.

Answer 1

1. In this case accrual and disclosure is required as:-

a) It is probable that the claim will be asserted

b) The probability of unfavourable outcome is high

c) The amount of loss can be reasonably estimated

As in this case all the above conitions are satisfied, there provision of the same should be made along with proper disclosure in financial statements. A provision results in reduction of profits and a disclosure is required stating i) opening and closing balance ii) Amount used iii)Addition during year iv) amount reversed

2. It should not be recognised in the books of accounts as the same is contingent liability. Disclosure by way of a footnote to the balance sheet, or as separate annexure is to be done. The certaining of unfavourable occurance is there but the amount cannot be estimated.

3. It is a case of contingent asset as the outcome will be favourable to Pratt. As per IFRS, Contingent assets should not be recorded in the books of account due to CONSERVATISM convention. As it may result in recognition of income that may or may not be realized.

Contingent assets should not be disclosed in the Financial statements but can be reported in the report of Approving authority.