Question

Aussie Vintage Cars Pty Ltd has been operating a successful business for many years specialising in servicing and providing replacement parts for vintage cars. 5% of customers who received a replacement part found that it broke within one month. On the 1 July 2020, the owner decided to offer customers a warranty on replacement parts that are installed in the cars and requests that the Accounting Department set up a provision account to cover future warranty expenses. The manager asked you, the company accountant, whether the provision for warranty account can be disclosed as a contingent liability in the Notes to the Financial Statements as at 30 June 2021.

What is contingent liability, and does it apply in this situation? Can provision for warranty be recognised as a contingent liability according to the Notes to the Financial Statements? What would you recommend to the manager the item be recorded as?

In your response, ensure you reference the Conceptual Framework definition and recognition criteria of a liability, and AASB 137 Provisions, Contingent Liabilities, and Contingent Assets.

Answer 1

A contingent liability is a liability which should satisfy below 2 conditions

· A possible obligation depending on whether some uncertain future event occurs

· A present obligation but payment is not probable

· The amount of liability cannot be measured reliably

Contingent liability does not apply in current case because there is no uncertain future event and the event sales have already happened. Also there is a present obligation as a result of past event. Hence a Provison for warranty cannot be recognised as Contingent liability according to notes to the financial statements.

The recommendation is to record the Provison for warranty as liabilities due to following reasons:

· There is present obligation as a result of past events (Sales in this case)

· Settlement is expected to result in outflow of resources

Also the warranty claim is probable given that 5% customers have made claims in the past. Hence provision should be given based on estimate available.

Note: no reference is given as per answering guidelines