Question

Question 1 Provisions and Contingencies                                                     

Below are three independent situations.

1. ABC Ltd is a manufacturer of boats and gives warranties at the time of sale to purchasers of its boats. Pursuant to the warranty terms, ABC Ltd undertakes to make good, by repair or replacement, manufacturing defects that become apparent within three years from the date of sale.
2. ABC Ltd has a number of non-current assets, some of which require, in addition to normal ongoing maintenance, substantial expenditure on major refits/refurbishment at certain intervals or on major components that require replacement at regular intervals.
3. XYZ Ltd is a listed company that provides food to functional centres that host events such as wedding and engagement parties. After an engagement party held by one of XYZ Ltd’s customers in May 2020, 50 people became ill, possibly as a results of food poisoning from products sold by XYZ Ltd. Legal proceedings were commenced seeking damages from XYZ Ltd. XYZ Ltd disputed liability by claiming that the functional centre was at fault for handling the food incorrectly. Up to the date of 30 June 2020 (financial year-end), XYZ Ltd’s lawyers advise that it was probable that XYZ Ltd would not be found liable.

REQUIRED:

Should a liability in the form of a provision be recorded? Briefly justify your decisions.

Answer 1

Events	Present obligation as a result of a past obligating event	An outflow of resources embodying economic benefits in settlement	Conclusion
1)	The obligating event is the sale of the product with a warranty, which gives rise to a legal obligation.	Probable for the warranties as a whole	A provision is recognized for the best estimate of the costs of making good under the warranty products sold before the balance sheet date
2)	There is no present obligation.		No provision is recognized.
			The cost of replacing the parts is not recognized because, at the balance sheet date, no obligation to replace exists independently of the company's future actions; even the intention to incur the expenditure  depends on the company's deciding to continue operating non current assets.
3)	On the basis of the evidence available when the financial statements were approved, there is no obligation as a result of past events.	-	No provision is recognized. The matter is disclosed as a contingent liability unless the probability of any outflow is regarded as remote.