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Review and ReportingIAS 37ProvisionsContingent Liabilities

ACCA · Question 07 · Review and Reporting

SECTION A - CASE 2: GREENHARVEST CO-OP

SCENARIO:
You are the audit senior for GreenHarvest Co-op, a large agricultural cooperative, for the year ended 31 March 20X5. The audit is nearing completion. During the review phase, you note the following:

  1. A major customer, representing 15% of receivables, went into liquidation on 15 April 20X5.
  2. GreenHarvest is facing a lawsuit from a supplier regarding contaminated fertilizer, which the legal counsel advises has a 30% chance of success.
  3. The directors have refused to disclose a key executive's remuneration, which is required by local legislation, though the amount is immaterial to the financial statements as a whole.

QUESTION:
Based on the legal counsel's advice that the lawsuit has a 30% chance of success, what is the correct accounting treatment under IAS 37 Provisions, Contingent Liabilities and Contingent Assets?

Answer options:

A.

Recognize a provision for the full amount claimed.

B.

Recognize a provision for 30% of the amount claimed.

C.

Disclose as a contingent liability in the notes to the financial statements.

D.

Do nothing, as the chance of success is less than 50%.

How to approach this question

Apply the IAS 37 definitions: Probable (>50%) = Provision. Possible (<50% but not remote) = Contingent Liability disclosure. Remote = Do nothing.

Full Answer

C.Disclose as a contingent liability in the notes to the financial statements.✓ Correct
Under IAS 37, an outflow of resources is considered 'probable' if it is more likely than not (i.e., >50%). Since the chance is 30%, it is not probable, so no provision is recognized. However, it is 'possible' (not remote), so it must be disclosed as a contingent liability.

Common mistakes

Students often think they should provide for 30% of the value, confusing single obligation rules with expected value methods for large populations.
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