Current Liabilities, Provisions and Contingencies a02fe22ccfaaadc 8a80b17c8907a4371 PDF

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CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES(Adapted from Intermediate Accounting, 2014 Edition by Nenita S. Robles and Patricia M. Empleo) By Ms. Sharon A. Bactat and Prof. Suerte R. Dy If a single obligation is being measured, the amount to be recognized as a liability is the most likely ou...

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CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES (Adapted from Intermediate Accounting, 2014 Edition by Nenita S. Robles and Patricia M. Empleo) By Ms. Sharon A. Bactat and Prof. Suerte R. Dy  If a single obligation is being measured, the amount to be recognized as a liability is the most likely outcome.  Where the amount of the obligation is still uncertain as of the end of the reporting period, but the obligation is settled subsequently before the issuance of the fiancial statements, the amount shown in the statement of fiancial position is the amount actually settled subsequently.  Where the provision being measured involves a large population of items, the obligation is estimated by weighting all possible outcomes by their associated possibilities (statistical method called “expected value”). Where there is a continuous range of possible outcomes, and each point in that range is as likely as any other, the midpoint of the range is used.  Where the effect of the time value of money is material, the amount of a provision should be the present value of the expenditures expected to be required to settle the obligation.  Where some or all of the expenditure required to settle a provision is expected to be reimbursed by another party, the reimbursement should be recognized when, and only when, it is virtually certain that reimbursement will be received if the enterprise settles the obligation. The reimbursement, if virtually certain, should be treated as a separate asset. The amount recognized, for the reimbursement should not exceed the amount of the provision. Let us apply the principles and concepts in the following CASES: 1. In September 2019, Happy filed a suit against Lonely Company, alleging violation of patent rights and it is seeking payment for damages of P7,000,000. Lonely disclaims the charges and the legal counsel advises that as of the date of the issuance of Lonely Company’s financial statements, it is probable that the enterprise will not be found liable.  No provision is recognized, because based on the evidence available as of the fiancial statement, there is no obligation as a result of past events. The matter is disclosed as a contingent liability, unless the probability of any outflow is regarded as remote. 2. ABC Company operates in a city where there is no environmental legislation. However, the company has a widely published policy in which it udertakes to clean up all contamination it causes. As of the date of the issuance of its 2019 financial statements, a reasonable estimate of the cost of this clean up related to 2019 oprations is P2,000,000.  A provision is recognized for the estimated amount of the costs of the clean-up, which is P2,000,000. The obligating event is one of a constructive obligation. The entry for the recognition of the provision is: Environmental Clean-Up Expense Provision for Environmental Clean-Up

2,000,000 2,000,000

3. As a result of an uninsured accident during the year 2019, a personal injury suit for P3,000,000 has been filed against XYZ Company. It is the judgment of the company’s legal counsel that an unfavorable verdict will result in a loss ranging from P1,800,000 to P2,800,000. The lawyer believes that the most reasonable estimate is P2,200,000.  A provision is recognized for the best estimate of the obligation. The best estimate is the most likely outcome which is P2,200,000. The entry for the provision is:

1

Loss from Accident Provision for Damages

2,200,000 2,200,000

Additional possible obligation of P600,000 (the difference between the recorded amount of P2,200,000 and the highest in the range of estimated amounts of P2,800,000) is to be disclosed in the notes to the financial statements. 4. GHI Company sells goods with a warranty under wjich customers are covered for the cost of any manufacturing defects that become apparent within the first year after purchase. If minor defects were detected in all products sold, repair costs of P2 million would result. If major defects were detected in all products sold, repair costs of P5 million would result. The enterprise’s past experience and future expectations indicate that 60% of the goods sold have no defects, 30% of the goods sold have minor defects, and 10% of the goods sold have major defects.  It is probable that the sale of defective merchandise will result in an outflow of economic benfits. Thus, the sale created an obligation. The best estimate of the obligation is the “expected value of the outcome,” which is derived by weighting all possible outcomes by their associated probabilities. Thus, the provision shall be measured as follows: No defects Minor defects Major defects Amount of provision

P0 x 60% P2M x 30% P5M x 10%

P

0 600,000 500,000 P1,100,000 =========

The entry to recognize the provision is: Warranty Expense Provision for Warranty (or Estimated Liability Under Warranty)

1,100,000 1,100,000

5. JKL is charged with multiple lawsuit because of an incident that happened in February 2019, cusing death of about 80 persons due to stampede in a sales promotion program it was airing through Channel 6 on February 10, 2019. Based on similar incidents suffered by other entities, JKL’S legal counsels are of the opinion that it is probable that JKL would be found liable for the incident. As of the date of the issuance of the 2019 financial statements, a reasonable estimate of the obligation is between P16,000,000 to P24,000,000. Each point within the range is as likely as any other.  The provision being measured above involves a large population of items and there is a continuous range of possible outcomes. There is no better estimate in the range, and each point within that range is as likely as any other point. Thus, the provision shall be measured at the midpoint of the range. The midpoint is the simple average or the mean, thus, (P16,000,000 + P24,000,000) divided by 2 equals P20,000,000. The entry to set up the provision is: Loss from Damages Provision for Damages

20,000,000 20,000,000

Review of the Amount Previously Recognized as Provision If based on subsequent review of the amount of the provision, there is a need to adjust the previously recorded amount, the adjustment is treated as a change in accounting estimate and would affect profit or loss of the current year. Thus, if based on the review of the provision, the amount needs to be decreased, the entry in a subsequent reporting period is to debit the provision and credit an appropriate expense, loss or in some cases, an income account. 2...