Question

Below are three independent situations.
1.   ABC Ltd is a manufacturer of boats and gives warranties at the time of sale to purchasers of its boats. Pursuant to the warranty terms, ABC Ltd undertakes to make good, by repair or replacement, manufacturing defects that become apparent within three years from the date of sale.
2.   ABC Ltd has a number of non-current assets, some of which require, in addition to normal ongoing maintenance, substantial expenditure on major refits/refurbishment at certain intervals or on major components that require replacement at regular intervals.
3.   XYZ Ltd is a listed company that provides food to functional centres that host events such as wedding and engagement parties. After an engagement party held by one of XYZ Ltd’s customers in May 2020, 50 people became ill, possibly as a results of food poisoning from products sold by XYZ Ltd. Legal proceedings were commenced seeking damages from XYZ Ltd. XYZ Ltd disputed liability by claiming that the functional centre was at fault for handling the food incorrectly. Up to the date of 30 June 2020 (financial year-end), XYZ Ltd’s lawyers advise that it was probable that XYZ Ltd would not be found liable.
REQUIRED:
Should a liability in the form of a provision be recorded? Briefly justify your decisions.

Answer 1

1. Provision is required

An entity must recognise a provision if, and only if: [IAS 37.14]

a present obligation (legal or constructive) has arisen as a result of a past event (the obligating event), payment is probable ('more likely than not'), and the amount can be estimated reliably.

An obligating event is an event that creates a legal or constructive obligation and, therefore, results in an entity having no realistic alternative but to settle the obligation. [IAS 37.10]

A constructive obligation arises if past practice creates a valid expectation on the part of a third party.

Here there is a constructive obligation and provision should be recorded.

2. No provision is recognised because we have no obligation here. you can avoid the obligation to pay with some future actions like sale of tye asset.

3. No provision required

Recognize when all of the following criteria are met:

A past event gives rise to a present obligation (legal or constructive).

It is probable – i.e. more likely than not – that an outflow of resources (typically a payment) will be required to fulfil the obligation.

The amount can be estimated reliably.

Here the at the reporting date the probability of the outflow is low. So we should not record provision.