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Distinguish between a contingent liability and provision. Your discussion should include how each item is disclosed in the financial statements.

INSTRUCTIONS TO CANDIDATES
ANSWER ALL QUESTIONS
  1. Distinguish between a contingent liability and provision. Your discussion should include how each item is disclosed in the financial statements. (3 marks) 
  1. Explain in accordance with IAS 37 whether each of the following situations would be a liability, a provision, or a contingent liability. Give journal entries where a liability or provision is recognized.
  • As a result of its plastics operations, Pactrade Ltd has contaminated the land on which it operates. There is no legal requirement to clean up the land, but Pactrade Ltd has a long record of cleaning up land that it has contaminated. (2 marks)
  • An amount of $50,000 owing to BDO for services rendered during April 2019. (2 marks)
  • Damages awarded against Company N resulting from a court case decided on 20 May 2019. The judge has announced that the amount of damages will be set at a future date, expected to be in August 2019. Company N has received advice from its lawyers that the amount of the damages could be anything between $20,000 and $8 million. 
  1. Flower Ltd estimates that it will be required to pay $100,000 in 2 years’ time to settle a warranty obligation. The risk-free discount rate applied is 5%. The probability of cash outflows has been assessed (i.e. adjusted for risk) in determining the $100,000. 

Required:

  • Complete the table below to show how the provision is accreted over the 2 years. Round to the nearest whole number. (4 marks)

The following table shows how the provision is accreted over the 2 years:

A.

Year

B.

Present value at beginning of the year

C.

Interest expense at 5%

D.

Cash Flows

E.

Present value at end of year

1

90,703

 

0

 

2

 

 

(100,000)

-

Prepare the journal entries to record warranty provision in years 1 to 2 and the settlement of provision in year 2.   (4 marks)

 

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