Question

1. In the year 2018, a director was dismissed and he commenced an action against the company claiming substantial damages for wrongful dismissal. The company's lawyer advised that the ex-director was likely to succeed with his claim estimated to be $1,000,000. In 2019, this case was still unsettled and the company has just found some new evidence showing that the possibility of success of the ex-director's claim was lower, around 30% as advised by the company's lawyer.

Required:

What was the accounting treatment for the claim for 2018 and 2019? Justify your answer. Provide journal entries where applicable. Limit your answer to 50 words.

2. Simple limited is preparing its financial statements for the year ended 31 December 2019. Before the authorization of financial statements for issue, the following material events took place:

(a) Simple Limited holds a portfolio of shares listed on the Hong Kong Stock Exchange as at the reporting date. The fair value of the investment portfolio of shares on the reporting date was $3.5 million. The value of such investments had deteriorated by 30% since the reporting date.

(b) Simple Limited carries its inventory at the lower of cost and net realizable value. On 20 January 2020, the company entered into an agreement to sell part of its inventory for $1 million. The cost of inventory as reported in its statement of financial position was $1.5 million.                             

Required;

Suggest and explain the accounting treatment for each of the above items. Justify your answers. Provide journal entries where applicable.

Answer 1

Requirement 1

It is change in estimate hence accounted for prospectively hence no change is made in the $1,000,000 figure reported for 2018; the gain on change in estimate of $700,000 is recognized in Y2019 (since sucess is around 30% as advised by the company's lawyer). The contingency amount is revised at the time that a better estimation (or final figure) is available. Entry in 2018

Estimated Liability Dr... $700,000

Gain on revision in estimate Cr.....$700,000

Requirement 2 a

The value of such investments had deteriorated by 30% since the reporting date. This event do not relate to conditions existing at the balance sheet date. Temporary fluctuations in market values generally do not relate to the condition of the investments existing at the balance sheet date, but are reflective of circumstances which took place in the following period. Hence, no adjustment is required on the reporting date

Requirement 2 b

Sale of inventory subsequent to reporting date below the carrying value provides latest evidence that the net realizable value was less than cost at the balance sheet date. Hence, the value of inventory is written down to realizable value of $1 million.

Loss expense reducing inventory to LCM Dr.... $0.5 million

Allowance, reducing inventory to LCM Cr....   $0.5 million