Question

8. A customer has initiated a lawsuit against an Entity ABC Limited associated with personal injury when using one of the entity’s products. The entity’s lawyers estimate from experience that at the reporting date (31 December 2017) the entity has a 30 percent chance of being ordered to pay the customer compensation of $2 million and a 70 percent chance of being ordered to pay compensation of $300,000. The ruling is expected to take place in two years’ time. Discuss how ABC Limited should treat this case in their financials.

Answer 1

Solution :

In this case the timing and amount is uncertain therefore as per the definition of IAS - 37, this comes under the purview of Provision.

A provision is nothing but a liability with uncertainty regards to amount and timing of the event.

Hence in this case the company needs to create provision for it as per the prediction given by the lawyer.

An entity must recognise a provision only if:

1. a present oblig­a­tion (legal or con­struc­tive) has arisen as a result of a past event (the oblig­at­ing event),

2. payment is probable and

3. the amount can be estimated reliably.

In our casestudy as per the given facts, there is a given estimate of the probable liability arising and there is no option but to settle the legal suit and compulsorily there is a obligation arised, hence it completes all the points for recognition of provision. But since the ruling of case is expected to take place in two years time, for this year there should be created a contingent liability for a year since these event is not going to exist at the balance sheet date.

Therefore for current year end reporting these obligation is showed as contingent liability as a footnote to notes of accounts and next year it will be shown as provision in the books of accounts.