Question

Below are three independent situations.

1. ABC Ltd is a manufacturer of boats and gives warranties at the time of sale to purchasers of its boats. Pursuant to the warranty terms, ABC Ltd undertakes to make good, by repair or replacement, manufacturing defects that become apparent within three years from the date of sale.
2. ABC Ltd has a number of non-current assets, some of which require, in addition to normal ongoing maintenance, substantial expenditure on major refits/refurbishment at certain intervals or on major components that require replacement at regular intervals.
3. XYZ Ltd is a listed company that provides food to functional centres that host events such as wedding and engagement parties. After an engagement party held by one of XYZ Ltd’s customers in May 2020, 50 people became ill, possibly as a results of food poisoning from products sold by XYZ Ltd. Legal proceedings were commenced seeking damages from XYZ Ltd. XYZ Ltd disputed liability by claiming that the functional centre was at fault for handling the food incorrectly. Up to the date of 30 June 2020 (financial year-end), XYZ Ltd’s lawyers advise that it was probable that XYZ Ltd would not be found liable

   REQUIRED:

   Should a liability in the form of a provision be recorded? Briefly justify your decisions.

Answer 1

Provisions in accounting for an amount set aside to cover a probable future expense, or reduction in the value of an asset. In financial reporting provisions are recorded as a current liability on the balance sheet and then matched to the appropriate expense account on the income statement.

In all the above three cases a liability in form of a provision should be recorded because in all the cases the situation is is probable future expense.

1st Case -

In this first case ABC Ltd has to make Provision for warranty. Provision for warranty arises when a company sells products which customers are entitled to return for repair or outright replacement. It is based on matching concept which requires a company to estimate the the expected warranty payable and record it at time of sale.

2nd Case -

In second case ABC Ltd has to make repairs and maintenance provision. It is a cost added to the investment upfront, whereas the maintenance allowance is taken out of the rent every month. We include a repairs provision to ensure that there is some money set aside start of the investment in case there are any large unexpected cost early on.

3rd Case -

In third case XYZ Ltd has to make provision for the future expenses as the lawyers advise that it is probable that XYZ Ltd. would not be found liable so the event is contingent XYZ Ltd. has to make a liability in the form of a provision.