Question

On December 2, 2018, one of the oil and gas division’s wells exploded. It leaked a significant amount of oil into a nearby stream until it could be repaired. The repair was completed on December 27, 2018, but remediation of the site has just begun. It cost $800,000 to repair the well, as a number of attempts initially failed, and new components had to be fabricated to replace the damaged parts. Our CEO issued a press release soon after the explosion, stating that the company will bear the full cost for cleaning up the damage and returning the site to its original condition. It is estimated that it will cost between $2 million to $4 million to fully remediate the site. The process of remediation will likely take several years, as the process of cleaning up the site and the nearby waterway is complicated. What are the key financial reporting issues? Where possible. What is the potential impact of the issue on the balance sheet and income statement, and explain why an adjustment is required? If there are areas where judgment is involved, or the accounting treatment is not clear. What are the alternatives that are available and factors that need to be considered in choosing an alternative?

Answer 1

According to AS contingencies and events occuring after the balance sheet date a contingency is a condition or situation the ultimate outcome of which gain or loss will be known or determined only on the occurrence or non occurrence of of one or more uncertain future events.

Events occurring after the balance sheet date are those significant events which can be favorable or unfavorable that occur between the balance sheet date and the date on which the books of Accounts are approved by the authority.it can be of two types;

1.Those which provides further evidence of condition existed at the balance sheet date,

2.those which are indicative of conditions that arose subsequent to the balance sheet date.

So such events can be reported either by;

1.Making appropriate adjustments in the financial statements,

2.through report of the approving authority.

An event after the balance sheet date may require adjustments of reported values of assets,liability,expense,income and equity for the accounting period if the event is such as to provide evidence of conditions that existed at the balance sheet date.Such events are adjusting events.

The disclosure requirement here in Referred to apply only in respect of those contingencies or events which affects the financial position to a material extent.

So in the given case the estimated cost of $2 to $4 Mn can be disclosed by way of reports.

As per IAS - 37 Provisions, contingent liabilities and contingent assets a provision is a liability which can be measured only by using a substantial degree of estimation.and a liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic activities.

In the given case the the company has to see whether they need to provide a provision for the cost estimated.

$800,000 which is spend on repair will form part of the current year expense if such repair does not increase the revenue generating capacity of the plant,otherwise it will form part of the cost of the plant and the same will be depreciated over the useful life of the plant.So a repair cost is determined as revenue expenditure or capital expenditure based on the results of increase in capacity of the asset on which repair made.If its revenue expenditure then the total amount of $800000 should be debited to the statement of financial performance.

The provision is charged in the income statement when there is a probable outflow is certain.Otherwise it will form part of notes.

here the company is estimating a total cost of $ 2 million to $4 million,the same can be recognized in books only if ,

1.A present obligation(Legal or constructive) has arisen out of past events

2.Payment is probable

3.The amount can be estimated reliably.

In the given case since the above condition is not satisfied the company not required to recognize the provision in the books.then can show it by way of disclosing in notes.

If the provision is recognized in the books,the same will result in a reduction in the net profit of the company as well as the tax payable also get reduced for the year and the same will be displayed in the provision part of the balance sheet.