MN20018 Financial Accounting and Reporting AY 2016/2017

Provisions, Contingent Liabilities and Contingent Assets and Events After the Reporting
Period – Seminar Questions
MN20018

Seminar questions – provisions, contingencies and post balance sheet events

1. If information becomes available after the year end but before the directors have

signed the accounts giving further evidence of the condition that existed at the balance

sheet date, it must be disclosed by way of note. True or false?

2. A provision for future operating losses should:

a. Never be recognised

b. Always be recognised

c. Sometimes be recognised?

3. Below is a series of transactions and events that have arisen in relation to Stimpy plc.

The company’s year-end is 30 November 2004. The accounts are finalised by

management and authorised for issue on 31 January 2005.

A. At the start of the year Stimpy plc purchased a new office building at a cost of £1
million. The building has an estimated life of 50 years, but it contains a sophisticated
air conditioning system (included in the cost price – with a value of £80,000), which
will need replacing every ten years at a cost of £100,000. Stimpy plc intends to
depreciate the building at £20,000 per year and to provide £10,000 each year to
facilitate the replacement of the heating system.
B. Five people died after a wedding in September 2003 of food poisoning, possibly from
turkey sold by the company. Legal proceedings have started and are being contested
by Stimpy plc on the grounds that Wren plc supplied the ham. Therefore, the blame
cannot be pinpointed to the turkey. At the year end 30 November 2003, the legal
advisers considered that the loss was possibly, but during the current year they have
changed their mind considering it to be quite likely. They suggest that a settlement
may be in the region of £200,000 per person plus legal fees.
C. On 15 December 2004 Stimpy plc agreed to guarantee the debts of a major supplier to
the tune of £1 million (Stimpy has a net worth of £10 million of which £2 million is in
cash). Alternative sources of supply are available. However, Stimpy plc has had a
long successful relationship with the supplier and is keen to preserve their excellent
service.
D. On 2 February 2005 a major fire destroyed a warehouse worth £3 million. The
insurance only covers the premises up to the value of £1.5 million.

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MN20018 Financial Accounting and Reporting AY 2016/2017
Provisions, Contingent Liabilities and Contingent Assets and Events After the Reporting
Period – Seminar Questions
E. While performing their audit work in December 2004 the auditors discovered that an
error had been made in the valuation of the closing inventory in the prior year’s
accounts (ie at 30 November 2003). Inventories were overvalued by £750,000.

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MN20018 Financial Accounting and Reporting AY 2016/2017
Provisions, Contingent Liabilities and Contingent Assets and Events After the Reporting
Period – Seminar Questions
Requirement:

Explain how the above matters should be treated in the financial statements of

Stimpy plc for the year ended 30 November 2004 and, where appropriate, show

by journal entry the adjustment and outline any additional narrative disclosures

that are required. In each case relate your explanation to the relevant accounting

principles, International Accounting Standards and practice.

4. Events after the balance sheet date

Company B is a retailer with a 30 June financial year end. The financial statements
for 30 June 2005, include revenue, and a trade receivable of £50,000 in respect of a
large customer X. On 31 July 2005, before the financial statements were authorised
for issue, company B was advised by the liquidator of customer X that customer X
was insolvent and would be unable to repay the full amount owed to company B. The
liquidator advised company B in writing that he would be paying all of company X’s
creditors 10 pence in the pound for every pound owed. The liquidator estimated that
the amount would be paid in September 2005.
Requirement:
Explain the accounting treatment of the above transaction, in light of the relevant IAS
and detail the relevant journal entry (if required).

5. Provisions

A manufacturer gives warranties at the time of sale to purchasers of its product.

Under the terms of the contract for sale the manufacturer undertakes to make good, by
repair or replacement, manufacturing defects that become apparent within three years
from the date of sale. On past experience, it is probable (more likely than not) that
here will be some claims under the warranties.
Requirement:
Explain the accounting treatment for the prospective warranties in light of the relevant
IAS.

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MN20018 Financial Accounting and Reporting AY 2016/2017
Provisions, Contingent Liabilities and Contingent Assets and Events After the Reporting
Period – Seminar Questions

6. A company in the oil industry usually causes contamination when extracting oil, but
cleans up only when required to do so under the laws of the particular country in which it
operates. One country in which it operates has no legislation requiring cleaning up, and
the entity has been contaminating land in that country for several years. At 31 December
2005 it is virtually certain that a draft law requiring a clean up of land already
contaminated will be enacted shortly after the year end.

Requirement:

Explain the accounting treatment for the costs associated with cleaning up the land in

accordance with the relevant IAS.