Question

After meeting with representatives of your client, Western Manufacturing, you learn that they are involved with several contingencies. You must prepare a memo summarizing the appropriate accounting treatment for each situation described below in order to present it to the client representatives. Westerns fiscal year is the calendar year 2018 and the 2018 financial statements are issued on April, 2019.

1. During 2018, Western experienced labor disputes at three of its plants. Management hopes an agreement will soon be reached. However negotiations between the Company and the unions have not produced an acceptable settlement and, as a result strikes are ongoing at these facilities since April 2019. it is virtually certain that material costs will be incurred but the amount of possible costs cannot be reasonably ascertained.
2. In accordance with a 2016 contractual agreement with A.J. Conner Company, Western is entitled to $37 million for certain fees and expense reimbursements. These are written off as bad debts in 2017. A.J. Conner has filed bankruptcy. The bankruptcy court in March 2019 ordered A.J. Conner to pay 23 million immediately upon consummation of a proposed merger with Garner Holding Group.

a) include any journal entries and drafts of disclosure notes.

b) explain your reasoning

Answer 1

Memo

Date: October 2,2019

Sub: Suggested accounting treatment

1. IAS 37 Provisions, Contingent Liabilities and Contingent Assets outlines the accounting for provisions (liabilities of uncertain timing or amount) and contingent liabilities (possible obligations and present obligations that are not probable or not reliably measurable). Provisions are measured at the best estimate (including risks and uncertainties) of the expenditure required to settle the present obligation, and reflects the present value of expenditures required to settle the obligation where the time value of money is material.

An entity must recognise a provision if, and only if:

• a present obligation (legal or constructive) has arisen as a result of a past event (the obligating event),
• payment is probable ('more likely than not'), and
• the amount can be estimated reliably

Moreover, where there is a present obligation but the amount cannot be measured reliably, a contingent liability should be disclosed unless the possibility of economic outflow seems remote.

Since,in the above fact pattern,while it is certain that material costs will be incurred, there seems no legal or constructive obligation (in the form of formal announcements) to expend those costs as yet. Further, the amount of such expenses cannot be estimated reliably. Therefore, these expenses should not be recorded as a provision.However, a contingent liability for the said expenses should be disclosed.

2. Occasionally, a bad debt previously written off may subsequently settle its debt in full or in part. In such case, it will be necessary to cancel the effect of bad debt expense previously recognized up to the amount settlement.

So, journal entry shall be

Bank A/c    Dr         23 $million

    To Bad-debts recovered A/c   23 $million

Additionally, in 2017, when the bad debts were written off, the entity would have journlaized the following:

Bad-debts expense A/c   Dr   37 $million

                        To Receivalbe A/c   37 $million