Question

11‐10 Reporting Contingencies

The following three independent sets of facts relate to (1) the possible accrual or (2) the possible disclosure by other means of a loss contingency.

Situation 1

A company offers a one‐way warranty for the product that it manufactures. A history of warranty claims has been compiled, and the probable amount of claims related to sales for a given period can be determined.

Situation 2

Following the date of a set of financial statements, but before the issuance of the financial statements, a company enters into a contract that will probably result in a significant loss to the company. The amount of the loss can be reasonably estimated.

Situation 3

A company has adopted a policy of recording self‐insurance for any possible losses resulting from injury to others by the company’s vehicles. The premium for an insurance policy for the same risk from an independent insurance company would have an annual cost of $2,000. During the period covered by the financial statements, no accidents involving the company’s vehicles resulted in injury to others.

Required:

Discuss the accrual of a loss contingency and/or type of disclosure necessary (if any) and the reason(s) such a disclosure is appropriate for each of the three independent sets of facts given. Complete your response to each situation before proceeding to the next situation.

Answer 1

Answer is as under:

IAS 37 Provisions, Contingent Liabilities and Contingent Assets defines Contingent liabilities as a possible obligation which may arise in future as results of an uncertain outcome. It may or may not occur and possible cash out flow of the same cannot be calculated exactly here. Egg are Likelihood of lawsuits. product warranty.

Contingent liabilities required companies to give discolours in notes to account and should not recognised the same in financial statement. As it is not a present obligation as a result of past event and its obligation on balance sheet is not more likely probable it does not required to be recorded. It is any non adjusting event . When the probability of a contingent liability is low then is no journal entry is required in the books of accounts. There is not 100 % accuracy in measurement of possible outflow

When there is medium probability of occurrence of contingent liabilities then a disclosure is required to be given in the notes accompanying the financial statement of the company as there is likelihood that a warranty claim could arise as a result of defect in new product which is recently introduced.Hence Contingent liability note can be given in with notes to the financial statement but it is not required to recognized in profit and loss account and balance sheet

Situation 1

A company offers a one‐way warranty for the product that it manufactures. A history of warranty claims has been compiled, and the probable amount of claims related to sales for a given period can be determined.

Here ,the company offers a one year product warranty and the probable amount of claims for a period can be determined. The company should use the expense warranty accrual method which, “assumes that the company makes the warranty offer to increase sales and, therefore, matches the estimated warranty expense against these sales.” As the potential loss is probable based on a history of warranty claims, and the amount for the given period can be determined, the amount will be accrued.

Situation 2

Following the date of a set of financial statements, but before the issuance of the financial statements, a company enters into a contract that will probably result in a significant loss to the company. The amount of the loss can be reasonably estimated.

Contract was entered into subsequent to the date of the financial statements. It will prevents accrual of the loss eventuality in financial statements for periods prior to the loss. The facts regarding the issuance of contracts should be disclosed in a note in the financial statements. The disclosure should contain the nature of the contingency and an estimate of the amount of the probable loss.

Situation 3

A company has adopted a policy of recording self‐insurance for any possible losses resulting from injury to others by the company’s vehicles. The premium for an insurance policy for the same risk from an independent insurance company would have an annual cost of $2,000. During the period covered by the financial statements, no accidents involving the company’s vehicles resulted in injury to others.

Company chooses to self-insure the injury to others caused by its vehicles is not enough of a basis to accrue a loss that has not occurred at the date of the financial statements. An accrual cannot be made for the amount of insurance premium that would have been paid had a policy been obtained to insure the company against a particular risk. The fact that the company is self- insuring this risk should be disclosed by means of a note to the financial statement.