Question

Go Party Ltd (GPL) is a successful New Zealand catering company, operating in South Island. It has a balance date of 30 June. During the preparation of the 30 June 2020 financial statements, the following two issues have come into the light. The details of these issues are as follows:

(a) After a wedding party held by a customer in January 2020, 60 people became seriously ill, possibly as a result of food poisoning from food served by GPL. Legal proceedings were commenced seeking damages from GPL. The company lawyers advised that owing to developments in the case, and it was probable that the company would be found liable and the estimated damages were $85,000 that would be material to the company’s reported profits.

(b) On 15 February 2020, the Department of Occupational Health and Safety undertook an audit against the complaints regards to the company’s unsafe storage practices. If found to be negligent by the court, the company will have to pay a fine and incur cleaning costs. At the end of the financial year, the outcome of the audit is unknown. The company directors are of the opinion that there is a 50% chance that Go Party Ltd will be found negligent.

Required: Determine how GPL should treat the above two issues in its financial statements for the year ended 30 June 2020. Include in your answer the criteria as per NZ IAS 37, necessary journal entries (if required) or any disclosure note/s required.

Answer 1

As per NZ IAS 37 Provisions, Contingent Liabilities and Contingent Assets,

Provision is defined as “A Liability of uncertain timing or amount.

A provision is to be recognised when all these conditions are met:

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

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

(c) a reliable estimate can be made of the amount of the obligation.

If these conditions are not met, no provision shall be recognised.

a)

Facts of the case:

There exists a legal proceeding against GPL seeking damages from the company.

The lawyers are opining that it is probable that GPL will have to incur damages to the tune of $85,000.

Now,

In this case there is

• Present obligation as result of past event;

o Obligation is a legal obligation to pay damages.

o Past event being rendering of catering services at a wedding.

• Probable that outflow will occur;

o Lawyers have confirmed the outflow will have to incurred.

• Reliable estimate can be obtained.

o Reliable amount is estimated i.e., $85,000

Considering all the above factors a provision is to be created to the extent of $85,000 as it is material to the profits of the company.

Scheme of Journal Entries

Creation of Provision on 30-6-2020
Dr/Cr	Account	Amount [$]
Dr	Legal Damages	85,000
Cr	Provision for Legal Damages		85,000
Subsequently payment of damages at a later date
Case 1:	Damage amount awarded by court is same as provision
Dr/Cr	Account	Amount [$]
Dr	Provision for Legal Damages	85,000
Cr	Bank		85,000
Case 2:	Damage amount awarded by court is more than provision
Dr/Cr	Account	Amount [$]
Dr	Legal Damages	5,000
Dr	Provision for Legal Damages	85,000
Cr	Bank		90,000
Case 3:	Damage amount awarded by court is less than provision
Dr/Cr	Account	Amount [$]
Dr	Provision for Legal Damages	82,000
Cr	Bank		82,000
Cr	Reversal of Provision for Legal Damages.		3,000
	[Shown as other income]

Disclosure Requirement:

§ the carrying amount at the beginning and end of the period;

§ additional provisions made in the period, including increases to existing provisions;

§ amounts used (i.e. incurred and charged against the provision) during the period;

§ unused amounts reversed during the period.

A brief description of nature obligation, it’s timing and resulting economic outflows

Illustrative Disclosure under this case (a)

Note on Provision

There has been a legal proceeding against the company for ill health of 60 people possibly as a result of food poisoning from food served by GPL. Legal proceedings were commenced seeking damages from GPL. Taking the opinion of company lawyers and developments in the case, it was probable that the company would be found liable and the estimated damages were $85,000 is provided as per NZ IAS 37. Based on the expert opinion of lawyers the damages would be incurred in the FY 2020-21.

Note No. XX	Amount [$]
	As on 30th June 2020	As on 30th June 2019
Provision for Legal Damages
Opening Balance	-	-
Created during the Year	85,000	-
Provision met during the year	-	-
Reversals	-	-
Total	85,000	-

b)

Facts of the case:

Company is subjected to an audit where it is found to negligent and towards health and safety practises. It is under audit because of unsafe storage practices.

Now,

In this case

There exists a need for provision as there as a liability ( Fine ) that is of uncertain timing and amount.

The word probable is defined as ‘More Likely than not’

But there’s an exact 50% chance. It can be constructed as it is not likely as it has equal chance of non-imposition of fine by authorities.

Generally a percentage over 50% is considered ‘ More likely than not’

So in conclusion

• Present obligation as result of past event;

o Obligation is a fine to the authorities.

• Probable that outflow will occur;

o Management is of the opinion that is exactly 50%.

• Reliable estimate can be obtained.

o Reliable amount cannot be estimated with facts of case.

Hence No Provision is created in this regard. Company may provide this fact as notes to accounts for better and enhanced use of users of financial statements.