IAS-37 Provisions, Contingent Liabilities and Contingent Assets

Q.No.1: The following information relates to the financial statements of Badar for the year to 31
March 2015.
The mining division of Badar has a 3 year operating licence from an overseas government. This
allows it to mine and extract copper from a particular site. When the licence began on 1 April
2014, Badar started to build on the site. The cost of the construction was Rs. 500,000.
The overseas country has no particular environmental decommissioning laws. In its past
financial statements Badar has given information about the company’s environmental policy and
has provided examples to demonstrate that it is a responsible company that believes in restoring
mining sites at the end of the extraction period. The cost of removing the construction at the end
of the three years is estimated to be Rs. 100,000.
The cost of the site currently shown in the trial balance is Rs. 500,000. The company has a cost
of borrowing of 10%.

Required:
Explain the correct accounting treatment for the above (with calculations if appropriate).

Q.No.2: Georgina Company is preparing its financial statements for the year ended 30
September 2015. The following matters are all outstanding at the year end.

1) Georgina is facing litigation for damages from a customer for the supply of faulty goods
on 1 September 2015. The claim, which is for Rs. 500,000, was received on 15 October
2015. Georgina’s legal advisors consider that Georgina is liable and that it is likely that
this claim will succeed. On 25 October 2015 Georgina sent a counter-claim to its
suppliers for Rs. 400,000. Georgina’s legal advisors are unsure whether or not this claim
will succeed.

2) Georgina’s sales director, who was dismissed on 15 September, has lodged a claim for
Rs. 100,000 for unfair dismissal. Georgina’s legal advisors believe that there is no case to
answer and therefore think it is unlikely that this claim will succeed.

3) Although Georgina has no legal obligation to do so, it has habitually operated a policy of
allowing customers to return goods within 28 days, even where those goods are not
faulty. Georgina estimates that such returns usually amount to 1% of sales. Sales in
September 2015 were Rs. 400,000. By the end of October 2015, prior to the drafting of
the financial statements, goods sold in September for Rs. 3,500 had been returned.
4) On 15 September 2015 Georgina announced in the press that it is to close one of its
divisions in January 2016. A detailed closure plan is in place and the costs of closure are
reliably estimated at Rs. 300,000, including Rs. 50,000 for staff relocation.

Required:
State, with reasons, how the above should be treated in Georgina’s financial statements for the
year ended 30 September 2015.
Q.No.3:Earley Inc is finalising its accounts for the year ended 31 December 2014. The following
events have arisen since the year end and the financial director has asked you to comment on the
final accounts.

a) At 31 December 2014 trade receivables included a figure of Rs. 250,000 in respect of

b) On 15 March 2015 Earley Inc sold its former head office building, Whitley Wood, for Rs.
2.7 million. At the year end the building was unoccupied and carried at a value of Rs. 3.1
million.

c) Inventories at the year-end included Rs. 650,000 of a new electric tricycle, the Opasney.
In January 2015 the European Union declared the tricycle to be unsafe and prohibited it
from sale. An alternative market, in Bongolia, is being investigated, although the current
price is expected to be cost less 30%.

d) Stingy Inc, a subsidiary in Outer Sonning, was nationalised in February 2015. The Outer
Sonning authorities have refused to pay any compensation. The net assets of Stingy Inc
have been valued at Rs. 200,000 at the year end.

e) Freak floods caused Rs. 150,000 damage to the Southcote branch of Earley Inc in January
2015. The branch was fully insured.

f) On 1 April 2015 Earley Inc announced a 1 for 1 rights issue aiming to raise Rs. 15
million.

Required:
Explain how you would respond to the matters listed above.

Q.No.4:You have been asked to advise on the appropriate accounting treatment for the following
situations arising in the books of various companies. The year end in each case can be taken as
31 December 2015 and you should assume that the amounts involved are material in each case.

a) At the year end there was a debit balance in the books of a company for Rs. 15,000,
representing an estimate of the amount receivable from an insurance company for an
accident claim. In February 2016, before the directors had agreed the final draft of the
published accounts, correspondence with lawyers indicated that Rs. 18,600 might be
payable on certain conditions.

b) A company has an item of equipment which cost Rs. 400,000 in 2012 and was expected
to last for ten years. At the beginning of the 2015 financial year the book value was Rs.
280,000. It is now thought that the company will soon cease to make the product for
 which the equipment was specifically purchased. Its recoverable amount is only Rs.
80,000 at 31 December 2015.

c) On 30 November a company entered into a legal action defending a claim for supplying
faulty machinery. The company’s solicitors advise that there is a 20% probability that the
claim will succeed. The amount of the claim is Rs. 500,000.

d) An item has been produced at a manufacturing cost of Rs. 1,800 against a customer’s
order at an agreed price of Rs. 2,300. The item was in inventory at the year-end awaiting
delivery instructions. In January 2016 the customer was declared bankrupt and the most
reasonable course of action seems to be to make a modification to the unit, costing
approximately Rs. 300, which is expected to make it marketable with other customers at a
price of about Rs.1,900.
e) At 31 December a company has a total potential liability of Rs. 1,000,400 for warranty
work on contracts. Past experience shows that 10% of these costs are likely to be
incurred, that 30% may be incurred but that the remaining 60% is highly unlikely to be
incurred.

Required:

For each of the above situations outline the accounting treatment you would recommend and
give the reasoning of principles involved. The accounting treatment should refer to entries in the
books and/or the year-end financial statements as appropriate.