Question

Barone, Inc. is involved with several situations that possibly involve contingencies. Each is described below. Barone's fiscal year ends December 31, and the 2018 financial statements are issued on March 1, 2019 Required: For each scenario described below, clearly articulate the appropriate means of reporting each situation, and the rationale 1) At March 1, 2019, the EPA is in the process of investigating possible chemical leaks at two of Barone's facilities, but has not proposed a deficiency assessment. Management feels an assessment is reasonably possible, and if an assessment is made an unfavorable settlement of up to $8 million is reasonably possible 2) Barone is the plaintiff in a S33 million lawsuit filed against Faze Corp. for damages due to lost profits from rejected contracts and for unpaid receivables. The case is in final appeal and legal counsel advises that it is probable that Barone will prevail and be awarded $25 million. 3) In July 2017, the State of Arkansas filed suit against Barone, seeking civil penalties and injunctive relief for violations of environmental laws regulating hazardous waste. On February 12, 2019, Barone reached a settlement with state authorities. Based upon discussions with legal counsel, the Company feels it is probable that $13 million will be required to cover the cost of violations 4) Barone is involved in a lawsuit resulting from a dispute with a customer. On January 5, 2019, judgment was rendered against Barone in the amount of $16 million plus interest, a total of $18 million. Barone plans to appeal the judgment and is unable to predict its outcome

Answer 1

IAS 37 Provisions, Contingent Liabilities and Contingent Assets sets 3 criteria for recognizing a provision:

1. There must be a present obligation as a result of a past event;

2. It is probable that outflow of resources will be required to settle obligation(i.e. more than 50% probable)

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

If all 3 criteria are met, then you should recognize a provision. Otherwise, it will be reported as contingent liability in the footnote of Financial Statement.

a) Since EPA is in the process of investigating a possible leak and has not proposed any deficiency assessment. There is no past event that can cause any obligation. Baron Inc is assessing that a future obligation is reasonably possible.As the first condition is not satisfied provision cannot be made. for this a contingent liability of $8 million will be reported as footnote.

b) Contingent Asset is a possible asset which arise from past event and comes into existence only by occurrence or non occurrence of an event. A contingent asset shall not be recognized in financial statement unless the entity is virtually certain of its materialization. Here, the legal counsel advises that it is probable that Baron Inc may win. there is no certainty. Hence no Contingent Asset should be recognized worth $25 million.

c) Here the liability has been materialized on Feb 12 2019 i.e, before the approval of financial statement on March 1 2019. Provision for  $13 million should be recognized As all three conditions as mentioned above is fulfilled.Liability has materialized but its amount is uncertain hence a provision is made.

d) On the basis of the evidence available when the financial statements were approved on march 1 2019 , there is an obligation as a result of past events. However, here there is absolute certainty of the amount of liability. thus, an amount of $ 18 million should be recognized in the financial statements as liability instead of a provision. As far as the question of appeal goes, it a future event that the company is still considering. If it ever goes into appeal, there is no certainty of its outcome.As for now liability is fully materialized.