I n t e r a c t I v e t e X t foundations in Accountancy/ acca financial accounting (ffa/FA) bpp learning Media is an acca approved Content Provider

 

201 

% of goods sold 

Defects 

Cost of repairs 

  

$m 

75 None – 

20 Minor 1.0 

 5 

Major 

4.0 

What should the warranty provision in Parker Co's financial statements be? 

Solution

 

Parker Co should provide on the basis of the expected cost of the repairs under warranty.  

The expected cost is calculated as (75%  $nil) + (20%  $1.0m) + (5%  $4.0m) = $400,000. 

Parker Co should include a provision of $400,000 in the financial statements.  

 

2

   Contingent liabilities and contingent assets 

A contingent liability must not be recognised as a liability in the financial statements. Instead it should 

be disclosed in the notes to the accounts, unless the possibility of an outflow of economic benefits is 

remote. 

A contingent asset must not be recognised as an asset in the financial statements. Instead it should be 

disclosed in the notes to the accounts if it is probable that the economic benefits associated with the 

asset will flow to the entity. 

2.1 Contingent liabilities 

Contingent liabilities are defined as follows. 

IAS 37 defines a 

contingent liability 

as: 

 

'a possible obligation that arises from past events and whose existence will be confirmed only by 

the occurrence or non-occurrence of one or more uncertain future events not wholly within the 

control of the entity; or 

 

a present obligation that arises from past events but is not recognised because: 

–

 

it is not probable that a transfer of economic benefits will be required to settle the 

obligation; or 

 

–

 

the amount of the obligation cannot be measured with sufficient reliability.' 

(para. 10) 

 

As a general rule, probable means more than 50% likely. If an obligation is probable, it is not a 

contingent liability – instead, a provision is needed. If the obligation is remote, it does not need to be 

disclosed in the accounts.  

Contingent liabilities should not be recognised in financial statements but they should be disclosed in 

the notes (IAS 37, paras. 27–28). The required disclosures are: 

 

A brief description of the nature of the contingent liability 

 

An estimate of its financial effect 

 

An indication of the uncertainties that exist 

 

The possibility of any reimbursement 

(IAS 37, para. 86) 

BPP Tutor Toolkit Copy

---