ExpertEasy2 marksMultiple Choice
ACCA · Question 18 · Provisions and Contingencies
A public utility company is facing a lawsuit from a local community group for environmental damage. The company's lawyers advise that it is possible, but not probable, that the company will lose the case and have to pay damages of $5 million. How should this be treated in the financial statements?
A public utility company is facing a lawsuit from a local community group for environmental damage. The company's lawyers advise that it is possible, but not probable, that the company will lose the case and have to pay damages of $5 million. How should this be treated in the financial statements?
Answer options:
A.
Recognized as a provision for $5 million in the statement of financial position.
B.
Disclosed as a contingent liability in the notes to the financial statements.
C.
Ignored completely as the outflow is not probable.
D.
Recognized as a contingent liability in the statement of financial position.
How to approach this question
Apply the rules of IAS 37 based on the probability of the outflow: Probable = Provision, Possible = Disclose Contingent Liability, Remote = Do nothing.
Full Answer
B.Disclosed as a contingent liability in the notes to the financial statements.✓ Correct
According to IAS 37 Provisions, Contingent Liabilities and Contingent Assets, if a present obligation exists but an outflow of resources is only 'possible' (less than 50% likely, but not remote), it is classified as a contingent liability. Contingent liabilities are not recognized in the financial statements but must be disclosed in the notes.
Common mistakes
Recognizing a provision when the outflow is only 'possible', or ignoring it completely.
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