A company is being sued for $500,000. The company's lawyers advise that it is possible (a 30% chance) that the company will lose the case. How should this be treated in the financial statements?

Answer options:

Recognized as a provision for $500,000

Recognized as a provision for $150,000

Disclosed as a contingent liability in the notes

Ignored completely

How to approach this question

Assess the probability of the outflow. Probable (>50%) = Provision. Possible = Disclose. Remote = Ignore.

Full Answer

C.Disclosed as a contingent liability in the notes✓ Correct

Under IAS 37, if an outflow of economic benefits is 'possible' (but not probable), a contingent liability is disclosed in the notes to the financial statements. No provision is recognized.

Common mistakes

Calculating an expected value ($500k * 30%) and recognizing a provision.

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