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

Ans:

As per NZ IAS 37, Provisions, contingent liabilities, contingent assets and reimbursements, Where, as a result of past events, there may be an outflow of resources embodying future economic benefits in settlement of

(a) a present obligation (or)

(b) a possible obligation

whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity.

• A provision is recognised, if there is a present obligation that probably requires an outflow of resources and also disclosures are required.
• For a contingent liability, disclosures are required if there are possible obligation or a present obligation that may, but probably will not, require an outflow of resources.

Based on the following points,

(a) Provision of $85,000 need to be made by the GPL as it a likely outflow of resource for the company and it should be disclosed in the financial statements because it is materially affecting the financial statements of the company.

(b) A simple disclosure will be needed for the event as there is a probable obligation and at the year end the result of the audit is unknown, therefore disclosure int he financial statements treating it as a contingent liability.