Question

In October 2018, 4 people died from a mystery virus after a cruise holiday on Fun Cruises. Their families started legal action against Fun Cruises in November 2018 for a total of $2,000,000, but the company disputes liability. Up to the date of authorisation of the financial statements for the year to 30 June 2019, the lawyers advise that it is probable that the entity will not be found liable. However, when Fun Cruises prepares the financial statements for the year to 30 June 2020, its lawyers advise that, owing to developments in the case relating to a faulty dishwasher, it is probable that they will be found liable. For the year ended 30 June 2019, how should Fun Cruises account for this item in its accounts?

Answer 1

Recognition of a provision

An entity must recognise a provision if, and only if: [IAS 37.14]

• 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.

An obligating event is an event that creates a legal or constructive obligation and, therefore, results in an entity having no realistic alternative but to settle the obligation. [IAS 37]

A constructive obligation arises if past practice creates a valid expectation on the part of a third party, for example, a retail store that has a long-standing policy of allowing customers to return merchandise within, say, a 30-day period. [IAS 37]

A possible obligation (a contingent liability) is disclosed but not accrued. However, disclosure is not required if payment is remote. [IAS 37]

In rare cases, for example in a lawsuit, it may not be clear whether an entity has a present obligation. In those cases, a past event is deemed to give rise to a present obligation if, taking account of all available evidence, it is more likely than not that a present obligation exists at the balance sheet date. A provision should be recognised for that present obligation if the other recognition criteria described above are met. If it is more likely than not that no present obligation exists, the entity should disclose a contingent liability, unless the possibility of an outflow of resources is remote. [IAS 37]

As per IAS 37 , As on 30/06/2019 the legal opinion is still favorable to the company so no need to provide any provision.