Contingent Liabilities

31. Contingent Liabilities

Rm Rm Bills, lease, and hire-purchase agreements discounted with recourse, other

Rm

622 296 194 guarantees and claims Litigation, current or pending, is not considered likely to have a material adverse effect on the group Buy-back and repurchase commitments not reflected on the balance sheet

1,071 222 The related assets are estimated to have a value at least equal to the repurchase commitment

There are no material contingent liabilities in join venture companies.

Wiley IFRS: Practical Implementation Guide and Workbook

MULTIPLE-CHOICE QUESTIONS

obligation. The entity that was sued should at year- 1. When can a “provision” be recognized in accor-

end:

dance with IAS 37? (a) Recognize a provision for this possible obli- (a) When there is a legal obligation arising from

gation.

a past (obligating) event, the probability of (b) Make a disclosure of the possible obligation the outflow of resources is more than remote

in footnotes to the financial statements. (but less than probable), and a reliable esti-

(c) Make no provision or disclosure and wait mate can be made of the amount of the obli-

until the lawsuit is finally decided and then gation.

expense the amount paid on settlement, if (b) When there is a constructive obligation as a

any.

result of a past (obligating) event, the out- (d) Set aside, as an appropriation, a contingency flow of resources is probable, and a reliable

reserve, an amount based on the best esti- estimate can be made of the amount of the

mate of the possible liability. obligation.

Answer: (b)

(c) When there is a possible obligation arising 4. A factory owned by XYZ Inc. was destroyed by from a past event, the outflow of resources

is probable, and an approximate amount can fire. XYZ Inc. lodged an insurance claim for the value be set aside toward the obligation.

of the factory building, plant, and an amount equal to (d) When management decides that it is essen-

one year’s net profit. During the year there were a tial that a provision be made for unforeseen

number of meetings with the representatives of the circumstances and keeping in mind this year

insurance company. Finally, before year-end, it was the profits were enough but next year there

decided that XYZ Inc. would receive compensation may be losses.

for 90% of its claim. XYZ Inc. received a letter that the settlement check for that amount had been mailed,

Answer: (b)

but it was not received before year-end. How should 2. Amazon Inc. has been served a legal notice on

XYZ Inc. treat this in its financial statements? December 15, 20X1, by the local environmental pro-

(a) Disclose the contingent asset in the foot- tection agency (EPA) to fit smoke detectors in its

notes. (b) Wait until next year when the settlement

factory on or before June 30, 20X2 (before June 30 of the following year). The cost of fitting smoke detec-

check is actually received and not recognize tors in its factory is estimated at $250,000. How

or disclose this receivable at all since at should Amazon Inc. treat this in its financial state-

year-end it is a contingent asset. ments for the year ended December 31, 20X1?

(c) Because the settlement of the claim was conveyed by a letter from the insurance

(a) Recognize a provision for $250,000 in the financial statements for the year ended De-

company that also stated that the settlement cember 31, 20X1.

check was in the mail for 90% of the claim, (b) Recognize a provision for $125,000 in the

record 90% of the claim as a receivable as it financial statements for the year ended De-

is virtually certain that the contingent asset will be received.

cember 31, 20X1, because the other 50% of the estimated amount will be recognized

(d) Because the settlement of the claim was next year in the financial statement for the

conveyed by a letter from the insurance year ended December 31, 20X2.

company that also stated that the settlement (c) Because Amazon Inc. can avoid the future

check was in the mail for 90% of the claim, record 100% of the claim as a receivable at

expenditure by changing the method of op- erations and thus there is no present obliga-

year-end as it is virtually certain that the tion for the future expenditure, no provision

contingent asset will be received, and adjust is required at December 31, 20X1, but as

the 10% next year when the settlement there is a possible obligation, this warrants

check is actually received. disclosure in footnotes to the financial

Answer: (c)

statements for the year ended December 31, 20X1.

5. The board of directors of ABC Inc. decided on (d) Ignore this for the purposes of the financial

December 15, 20XX, to wind up international opera- statements for the year ended December 31,

tions in the Far East and move them to Australia. The 20X1, and neither disclose nor provide the

decision was based on a detailed formal plan of re- estimated amount of $250,000.

structuring as required by IAS 37. This decision was conveyed to all workers and management personnel at

Answer: (c)

the headquarters in Europe. The cost of restructuring 3. A competitor has sued an entity for unauthorized

the operations in the Far East as per this detailed plan use of its patented technology. The amount that the

was $2 million. How should ABC Inc. treat this re- entity may be required to pay to the competitor if the

structuring in its financial statements for the year-end competitor succeeds in the lawsuit is determinable

December 31, 20XX?

with reliability, and according to the legal counsel it is (a) Because ABC Inc. has not announced the re- less than probable (but more than remote) that an

structuring to those affected by the decision outflow of the resources would be needed to meet the

and thus has not raised an expectation that

Chapter 29 / Provisions, Contingent Liabilities, and Contingent Assets (IAS 37)

ABC Inc. will actually carry out the re- structuring (and as no constructive obliga- tion has arisen), only disclose the restructur- ing decision and the cost of restructuring of $2 million in footnotes to the financial state- ments.

(b) Recognize a provision for restructuring since the board of directors has approved it and it has been announced in the headquar- ters of ABC Inc. in Europe.

(c) Mention the decision to restructure and the cost involved in the chairman’s statement in the annual report since it a decision of the board of directors.

(d) Because the restructuring has not com- menced before year-end, based on prudence, wait until next year and do nothing in this year’s financial statements.

Answer: (a)