Question

Case 2: You are an expert who deals with the transactions related to provisions, contingent assets, contingent liabilities and intangible assets. For each of the scenario mentioned below provide with an appropriate solution with accounting treatment, calculations and necessary comments: (4 x 2.5 marks each = 10 marks) 1. The company is sued for contributing to water pollution for RO 1.5 million and it believes that it will have to pay this amount in full. It will also have to pay RO 200,000 for making changes to its production plant to avoid any further legal action. 2. The company also has to rectify a serious fault in a piece of equipment that it had sold to a customer. The individual most likely outcome is that the repair will succeed at the first attempt at a cost of RO 30,000, but there is a chance that a further attempt will be necessary, increasing the total cost to RO 35,000. 3. The company owns various franchises that amounts to RO 100,000 on the balance sheet date. They all are currently held at cost. The company has decided to revalue only half of its franchise and remaining will be shown at cost. 4. The company also recently has bought a patent for RO 60,000 for a seasonal product. It is estimated that it will be valid for 20,000 units over its useful life. No residual value is anticipated. Around 5,000 units were tested by the end of the current year.

Answer 1

Answer 1

Recognition criteria of provision is there should be present obligation of the entity arising out of the past events where it is probable that there will be an outflow of economic resources to settle and amount is reliably measureable. Here, In this case, the company is sued for contributing to water pollution for RO 1.5 million and it believes that it will have to pay this amount in full. It will also have to pay RO 200,000 for making changes to its production plant to avoid any further legal action. Thus, the company should make a provision of amount estimated to be paid to settle the sue case filed. A provision of RO 200,000 should be made. Further, since further RO 200,000 is required for making changes to its production plant, so provision for such amount should also be made.

Answer 2

A provision for RO 30,000 is recognised. This is because the best estimate of the liability is that the repair will succeed at the first attempt at a cost of RO 30,000, which is the most likely outcome, not the worst-case scenario. Where a single obligation is being measured, the individual most likely outcome may be the best estimate of the liability. However, even in such a case, the entity considers other possible outcomes. Where other possible outcomes are either mostly higher or mostly lower than the most likely outcome, the best estimate will be a higher or lower amount.

Answer 3

A company can carry its tangible assets either at:

1. Cost model: The intangible asset is carried at its cost less accumulated amortization (similar as depreciation) less any accumulated impairment loss.
2. Revaluation model: The intangible asset is carried at its fair value at the revaluation date less accumulated amortization less any accumulated impairment loss.

If a company adopts any one model, then same model should be applied to all classes of assets that belong to that category of intangible asset. Hence, in the given case, the company cannot carry half of the franchise at cost and other half at fair value. It should carry all the franchise at either it cost or fair value.

Answer 4

An intangible asset acquired should be carried at cost if it the asset acquired meets the definition and recognition criteria of intangible asset. In the given case, The Company recently has bought a patent for RO 60,000 for a seasonal product. It is estimated that it will be valid for 20,000 units over its useful life. No residual value is anticipated. The said patent should be capitalised as and when it is acquired. It should be amortized whenever the units are tested. Around 5,000 units were tested by the end of the current year, therefore, during the current year, RO 15,000 (RO 60,000* 5000 units/20,000 units) should be amortized and rest RO 45,000 will be shown as an Intangible Asset in the financial statements.