Question

Eco State Sdn. Bhd. (ECOS) operates a chain of retail outlets. The Board of Directors decides not to buy the public liability insurance to cover the cost of compensation claims made against ECOS for injury or damage to its customers. The board of directors chooses to self-insure against potentially insignificant losses. ECOS expects to pay RM500,000 a year in respect of minor accidents to its customers. ECOS files a suit against its business partner for breach of contract. The company’s lawyers advise that a favourable settlement is highly probable. ECOS has had a number of these significant lawsuits in the past three years.

1. Discuss the accounting treatment for the above events in accordance with IAS 37/ MFRS 137 Provisions, Contingent Liabilities and Contingent Assets.

Answer 1

1	ECOS expects to pay RM500,000 a year in respect of minor accidents to its customers.
	As per IAS 37
	Provision:
	Provision is a present obligation arising as a result of past events and the settlement is expected to result in an outflow of resources
	Recognition of a provision
	An entity must recognise a provision if, and only if:
	-a present obligation has arisen as a result of a past event (the obligating event),
	-payment is probable, and
	-the amount can be estimated reliably.
	Contingent liability:
	-a possible obligation depending on whether some uncertain future event occurs, or
	-a present obligation but payment is not probable or the amount cannot be measured reliably
	Accounting treatment for Contingent liabilities
	A possible obligation (a contingent liability) is disclosed but not accrued.
	Since the given event is a is a possible obligation and not present obligation and amount cannot be estimated reliably. Provision shall not be created and hence shall be DISCLOSED in the financial statements
2	ECOS files a suit against its business partner for breach of contract.
	As per IAS 37
	Contingent Asset
	A contingent asset is a possible asset arising from past events that will be confirmed by some future events not fully under the entity’s control.
	Accounting treatment for Contingent Assets
	Contingent assets should NOT be recognised but should be disclosed where an inflow of economic benefits is probable.
	It is given that the company’s lawyers advise that a favourable settlement is highly probable. Further, it is also stated that ECOS has had a number of these significant lawsuits in the past three years and hence the claim amount can be measured.
	Hence, based on past three years, the estimated cash inflow shall be DISCLOSED in the financial statements of ECOS