Lecture Tutorial

Provisions and Contingencies

1. Diamond Bhd was sued by its competitor for patent infringement in October 2018. Its
legal advisers had determined that it is probable that Diamond Bhd will lose the case
and the estimated amount of damages will be RM300,000. Briefly explain how the
damages should be reported on the statement of financial position of Diamond Bhd
as at 31 December 2018.
Diamond Bhd has provision because the entity has present obligation from past
event, the outflow of resources to settle the obligation is probable, and the estimated
obligation amount can be reliably estimated. Therefore, Diamond Bhd should
recognize the provision for damages and the provision is reported either under
current liabilities or non-current liabilities, depending on when the payment is due.

2. Ruby Bhd acquired a piece of land from Dane Bhd for RM900,000 in August 2018. In
November 2018, it was discovered that the land was contaminated. As a result, Ruby
Bhd sued Dane Bhd for RM100,000. The legal advisors of Ruby Bhd believe that there
is a 80% chance of winning the case. Discuss how Ruby Bhd should account for this
lawsuit in its statement of financial position as at 31 December 2018.
Ruby Bhd has a contingent asset which is considered to be probable. Since the
contingent asset is not virtually certain, it is not recognized as an asset in the
Statement of Financial Position. The nature and estimated financial effect of the
contingent asset are disclosed in the notes to financial statement as at 31 December
2018.

3. Given below independent situations. For each situation, discuss how the entity should
account for the transactions in accordance with MFRS 137, Provisions, Contingent
Liabilities and Contingent Asset, giving reasons for your answer. Assume that the
accounting year end is 31 December 2018.

a During the financial year 2018, White Bhd
sued its main supplier for RM1.5 million
damages for faulty supply of materials
which has affected its production. As at
the reporting date, a decision was given
in favour of the entity. The hearing to
determine the amount of damages,
however, would only be held after the
reporting date.
White Bhd has a contingent asset
which is not virtually certain. The
entity needs to decide whether the
inflow of resources is probable or
possible.
If the outcome is considered to be
probable, it is not recognized as
asset in the Statement of Financial
Position (SoFP). However, the
nature and estimated financial
effect of the contingent asset are
disclosed in the notes to financial
statement as at 31 December 2018.

If the outcome is considered to be

possible, the entity does not have

b Green Bhd had an overseas subsidiary
involved in mining activities that caused
significant damage to the environment.
The mine was situated in a country where
there was no environmental regulation
requiring the entity to remedy
environmental damage. It was estimated
that the cost of restoration of the mining
site, which was estimated to be 10 years’
time, would probably be RM15 million.
c Blue Bhd sold goods with a warranty
where costumers are covered for the cost
of repairs due to manufacturing defects
within the first year after purchase. Blue
Bhd estimated that the probability of
goods sold with major defects will be 25%
and the estimated repair cost would be
RM2 million.
d Red Bhd was being sued by a customer for
RM2 million for breach of contract. Red
Bhd had obtained legal opinion that it was
not probable Red Bhd would lose the
case. Accordingly, Red Bhd had provided
RM400,000 which was included in
administrative expenses. The
uncoverable legal costs of defending the
action were estimated at RM500,000.
However, this amount had not yet been
to make any disclosure on the
contingent asset.
Green Bhd does not have legal
obligation to remedy the
environmental damage. However,
the entity may have constructive
obligation if it is the policy of the
entity to remedy any
environmental damage it has
caused and the policy is made
known to the public. Since the
amount can be estimated reliably,
Green Bhd should recognize the
provision in its SoFP. The amount to
be recognized will be the present
value of RM15 million.
On the other hand, if the entity has
no constructive obligation, it should
not recognize the provision in its
SoFP.
When Blue Bhd sells goods with
warranty, the entity has legal
obligation towards its customers.
Since the outflow of resources is
probable and the obligation
amount can be estimated reliably,
Blue Bhd should recognize the
provision of RM500,000 in its
financial statements.
Since the legal opinion indicated
that it was not probable that R Bhd
would lose the case, the entity
should not recognize the provision.
Therefore, RM400,000 which had
been recorded as administrative
expenses must be reversed by
debiting provision and crediting the
administrative expenses.
provided for as the legal action would In relation to the unrecoverable
only go to court in 2019.
legal cost of RM500,000, a
provision should be recognized
since the entity has present
obligation from past event
(appointing of lawyers), the
outflow of resources is probable
(payment for defending the entity)
and the obligation amount can be
estimated reliably (RM500,000).