Question

The draft financial statements of Pedro, a limited liability company, for the year ended 31 December 2019 are currently under review. The following points have been raised:

• An ex-employee has started an action against Pedro for wrongful dismissal. The company’s legal team have stated that the ex-employee is likely to succeed. The following estimates have been given by the lawyers relating to the case:

          a) Legal costs (to be incurred whether the claim is successful or not) $10,000

          b) Settlement of claim if successful $30,000

Currently no provision has been made by Pedro in the financial statements.

• Pedro has a policy of refunding the cost of any goods returned by dissatisfied customers, even though it is under no legal obligation to do so. This policy of making refunds is generally known. At the year end, Pedro reliably estimated that returns totalling $5,200 will be made after the year-end.

• A customer has made a claim against Pedro for injury suffered following the purchase and use of a defective product. According to legal advisers it is not likely that Pedro will have to pay financial compensation of $150,000 to the customer. In turn, Pedro has made a counter-claim against the supplier of the defective product for $120,000 and believes it is probable that its claim against the supplier will be successful.

State with reasons what adjustments, if any, should be made by Pedro`s in the financial statements

Answer 1

This Scenario comes under IAS 37 provsions act of IFRS(International Financial Reporting standards). First let me explain  you what is provisions? The menaing of Provision is that liability of uncertain timing or amount. Liability means present obligation from past event.  provsions are created when the event is probable and the amount is measurble.

• In the First case  an employee has been removed wrongfully , this is the present obligation of the past event, So provision has to be created for the Total amount $40,000 ( $30,000 Settlement of claim +  $10,000 Legal cost)  in Financial statements at the year end.
• in the second scenario  as per matching concept, possible provision for the sales return has to be created because  the sales has been made in past. hence provision of total $5,200 must recorded   at the year end financial statements
• Finally the company must recognize contingent asset for the possible outcome of the claim made to suppliers for the amount $120,000 and  recognize contingent liabilities of $150,000 in the notes of financial statements.