Question

The Drug Company developed a new sleeping pill. The drug is called Star and was approved by the FDA in 2016. In 2017 the company began to notice problems with this drug. People who were prescribed Star reported feeling sleepy during the next day and developing a dependence on this drug. The company reacted immediately and stopped selling Star near the end of 2017. In the last six months of 2018, the company was sued by 1,000 people who experienced grogginess and dependency reaction to the sleeping pill. At the end of 2018, the company’s attorneys believe there is a 60% chance the company will need to make payments in the range of $1,000 to $5,000 to settle each claim. At the end of 2019, while none of the cases have been resolved, the company’s attorneys now believe there is an 80% chance the company will need to make payments in the range of $2,000 to $7,000 to settle each claim. In 2020, 400 claims were settled at a total cost of $1.2 million. Based on this experience, the company believes 30% of the remaining cases will be settled for $3,000 each, 50% will be settled for $5,000 and 20% will be settled for $10,000 each. The company is in the process of the first-time adoption of IFRS and needs to report under US GAAP and IFRS, as required by IFRS 1. Using US GAAP and IFRS, show what journal entries would be required in 2017, 2018, 2019 and 2020.

Answer 1

Accounting for Contingencies :
				( Amount in $)
2017	Profit & Loss A/c                                                                                      Dr
	To Inventory A/c
	Being the inventory held by the entity should be written off as the entity has stopped sales at the end of the year 2017.
	And the entity should disclose for an amount the entity is expected to be liable for all the sales made during the year since the entity has started noticing problems with the drug.
2018	Profit & loss A/c                                                                                      Dr				18,00,000
	To Provision for claim settlement A/c					18,00,000
	[Being the amount provided for the probable percentage of claims to be settled as per WN#1.]
WN#1:	Amount to be provided :
	No.of people sued			1000
	The Probability that company needs to make payment			60%
	Range of amount to be paid to settle each claim			$1,000 to $ 5,000
	We will take an average amount of range to be incurred for each claim settlement and multiply with probable percentage of cases to be settled to arrive at the amount of provision to be created
	Average amount to be incurred for each and every case			3,000
	Amount of provision to be created			18,00,000
2019	Since none of the cases have been resolved, the entity has further revised its estimations and increased the percentage of claims to be attended to 80% with revised range of $2,000 to $ 7,000.
	Revised provision (WN#2) :
	Revised provision			36,00,000
	Existing provision in the books			18,00,000
	Additional provision yet to be created			18,00,000
	Provision to be created for the additional amount based on revision of estimates:
	Profit & loss A/c                                                                                      Dr				18,00,000
	To Provision for claim settlement A/c					18,00,000
WN#2 :	Amount to be provided :
	No.of people sued			1000
	Probability that company needs to make payment			80%
	Range of amount to be paid to settle each claim			$2,000 to $ 7,000
	We will take an average amount of range to be incurred for each claim settlement and multiply with probable percentage of cases to be settled to arrive at the amount of provision to be created
	Average amount to be incurred for each and every case			4,500
	Amount of provision to be created			36,00,000
2020	For settlement of claims made :
	Provision for claim settlement A/c                                                                         Dr				12,00,000
	To Bank A/c					12,00,000
	[Being amount paid for the settlement made to 400 people.]
	Amount to be provided for remaining 600 claims
	30% of 600 will be settled at $3,000 each				5,40,000
	50% of 600 will be settled at $5,000 each				15,00,000
	20% of 600 will be settled at $10,000 each				12,00,000
	Remaining provision should be made in the books				32,40,000
	But existing provision in the books at the end of 2020 before entry is passed				24,00,000
	Additional provision required to be made				8,40,000
	Profit & loss A/c                                                                                      Dr				8,40,000
	To Provision for claim settlement A/c					8,40,000
	[Being provision made for additional amount required to make settlement of claims]