Question

Sunny Ltd., a hand sanitizer manufacturer, has prepared its financial statements for the year ended at December 31, 2019. On February 28, 2020, the board of directors authorized to issue the financial statements to shareholders. The following events have occurred:

1. On December 1, 2019, the board of directors decided to issue $50,000,000, 9% convertible bonds for the purpose of expanding business in other countries. The conversion rate is fixed at 50 shares for bond with face value of $1,000. The convertible bonds are offered to the public on January 15, 2020. The market interest rate for a similar bond without conversion option is at 12%.

2. On October 23, 2019, Sunny signed a contract to sell 10,000 hand sanitizer to a local store at a price of $200 each. However, due to the increase in the cost of materials, the estimated cost of making one hand sanitizer has been increased to $250. Sunny has to deliver the hand sanitizer to its customer on January 30, 2020.

3. Under the terms of the sales contract, Sunny undertakes to recall its new formulated sanitizer, for its manufacturing defects within six months from the date of sale. The accountants estimated that 5% of the sanitizer will be returned for refund. In January 2020, Sunny discovered a serious problem in the manufacturing process of the new formulated sanitizer. Because of this, Sunny expected that 20% of the sanitizer sold in 2019 will be returned for refund.

4. On December 15, 2019, a group of customers reported that the hand sanitizer that they bought in 2019 caused them have serious skin infection problems. They filed a lawsuit against Sunny on December 20, 2019. The company’s attorney said that it was probable that Sunny would be liable for the case. However, the amount of damage could not be estimated.

5. On February 12, 2020, the above lawsuit case was settled for the amount of $2,500,000.

6. Sunny has retail stores in China doing poorly. On February 15, 2020, Sunny estimated that those stores might report a loss of $1,500,000 in 2020.

7. In May 2019, Sunny had legal disputes with Coco Limited. Unable to reach out-of-court settlement with Coco, Sunny sued Coco for compensation for damages in August 2018. In November 2019, Sunny heard good news about the lawsuit in which the company sued Coco. Sunny’s lawyer is confident that the company will win the case and will receive about $120,000 in compensation for damages from Coco in early 2020. Sunny recognized the gain and receivable from litigation of $120,000 in year 2019.

8. On March 1, 2020, a customer owing $600,000 to Sunny filed for bankruptcy. The financial statements include an allowance for doubtful debts pertaining to this customer only of $30,000.

Required: For each of the above event, state the correct accounting treatments in accordance with Hong Kong Accounting Standards for the year ended at December 31, 2019. If it is an event after the reporting period, identify whether it is an adjusting or non-adjusting event. Give reasons for your answer.

Answer 1

1) The convertible bonds are offered to public on 15th Jan 2020. Hence the proceeds out of the issue is collected after 31 December 2019. It is a non-adjusting event since event took place after the reporting date. However a suitable note will be disclosed in financials that the issue of band took place after the reporting period but before signing of the financials for the stakeholders. No Accounting implication for year ending 31 December 2019.

2) At the time of valuation of inventory, accounting treatment depends upon cost or net realizable vale which ever is lower. In the present case, cost is $250 and realizable value is only $200. The inventory at year end must be valued at $200 per sanitizer. It is not a subsequent event.

3) Sales return for sales made in current year but received subsequent to financial year is an adjusting event. The Company must account for these losses in the current year ending 31 December 2019. Adequate provision @20% must be carried in financials as per the accounting policy of the Company.

4) As per the accounting standards, if the status of the case is probable then the Company must admit the liability as contingent. Hence adequate disclosures must be made by the Company is Contingent liability section. Also the facts should be highlighted that the amount is still not confirmed.

5) Now since the case is settled and the liability is determined, its no more probable. It is an adjusting event as the event took place before the reporting period year end. So the Company must book a provision against the said liability.

6) Its non-adjusting event as there was no condition present at the balance sheet date which confirms that losses are present at year end date. The Company should account for these losses in the next year.

7) It is the case of recording contingent asset in the books at year end. As per the accounting standards, contingent asset must not be recorded in books until collections has been made against the same. As in this case no collection has been made at reporting year end date, hence no amount should booked on accrual basis.

8) The issue date for the financial statement is 28 Feb 2020 and company got bankrupt on 1 March 2020, hence financial statements are already issued by the Company. Question of adjusting and non-adjusting does not arise once financial statements are issued. If the loss is material to the Company then the Board may think to restate the financials.