ExpertMedium2 marksMultiple Choice
ACCA · Question 21 · Recording Transactions: Provisions and Contingencies
Section A
PharmaCorp is being sued by a competitor for patent infringement. PharmaCorp's lawyers advise that it is probable (a 70% chance) that PharmaCorp will lose the case and have to pay damages of $2 million.
How should this be treated in PharmaCorp's financial statements?
Section A
PharmaCorp is being sued by a competitor for patent infringement. PharmaCorp's lawyers advise that it is probable (a 70% chance) that PharmaCorp will lose the case and have to pay damages of $2 million.
How should this be treated in PharmaCorp's financial statements?
Answer options:
A.
Disclose as a contingent liability only.
B.
Recognize a provision for $1.4 million (70% of $2m).
C.
Recognize a provision for $2 million.
D.
Ignore it until the court case is finalized.
How to approach this question
Apply IAS 37 criteria for a provision: Present obligation? Yes. Probable outflow? Yes (70%). Reliable estimate? Yes ($2m). Therefore, recognize a provision for the full best estimate.
Full Answer
C.Recognize a provision for $2 million.✓ Correct
Under IAS 37 Provisions, Contingent Liabilities and Contingent Assets, a provision must be recognized when there is a present obligation, a probable outflow of resources, and a reliable estimate can be made. Since the loss is probable (70%), a provision for the full estimated amount ($2 million) is recognized.
Common mistakes
Calculating an expected value ($1.4m) for a single obligation, or confusing 'probable' with 'possible' and only disclosing it.
Practice the full ACCA FA — Financial Accounting Practice Exam 5
65 questions · hints · full answers · grading
More questions from this exam
Q01Section A
Quantum Innovations, a rapidly growing tech startup, is preparing its first set of for...EasyQ02Section A
MetroWater, a public utility company, is finalizing its annual report. The chief accou...MediumQ03Section A
GlobalHealth NGO receives a restricted cash grant of $50,000 specifically designated f...MediumQ04Section A
CircuitWorks manufactures specialized electronic components. At year-end, they have 1,...MediumQ05Section A
CodeCrafters Ltd is developing a new proprietary software platform. During the year, t...Easy