Concepts for Analysis 24-3 (Essay) Presented below are three independent situati

Question

Concepts for Analysis 24-3 (Essay) Presented below are three independent situations.

Situation 1: A company offers a one-year warranty for the product that it manufactures. A history of warranty claims has been compiled, and the probable amounts of claims related to sales for a given period can be determined.

Situation 2: Subsequent to the date of a set of financial statements but prior to the issuance of the financial statements, a company enters into a contract that will probably result in a significant loss to the company. The amount of the loss can be reasonably estimated.

Situation 3: A company has adopted a policy of recording self-insurance for any possible losses resulting from injury to others by the company’s vehicles. The premium for an insurance policy for the same risk from an independent insurance company would have an annual cost of $4,000. During the period covered by the financial statements, there were no accidents involving the company’s vehicles that resulted in injury to others.

Discuss the accrual or type of disclosure necessary (if any) and the reason(s) why such disclosure is appropriate for each of the three independent sets of facts above.

Explanation / Answer

Situation-1 : it is a contingent liability.

(a) a possible obligation that arisesfrom past events and the existence of which will be confirmed only by the occurrence or nonoccurrence of one or more uncertain future events not wholly within the control of the enterprise; or (b) a present obligation that arises from past events but is not recognised because: (i) it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or (ii) a reliable estimate of the amount of the obligation cannot be made.

Disclosure: Unless the possibility of any outflow in settlement is remote, an enterprise should disclose for each reclass of contingent liability at the balance sheet date a brief description of the nature of the contingent liability and, where practicable: (a) an estimate of its financial effect, measured under paragraphs 35-45; (b) an indication of the uncertainties relating to any outflow; and (c) the possibility of any reimbursement.

Situation 2

Events occurring after the balance sheet date are those significant events, both favourable and unfavourable, that occur between the balance sheet date and the date on which the financial statements are approved by the Board of Directors in the case of a company, and, by the corresponding approving authority in the case of any other entity. Two types of events can be identified: (a) those which provide further evidence of conditions that existed at the balance sheet date; and (b) those which are indicative of conditions that arose subsequent to the balance sheet date.

Disclosure: The accounting treatment of a contingent loss is determined by the expected outcome of the contingency. If it is likely that a contingency will result in a loss to the enterprise, then it is prudent to provide for that loss in the financial statements. If there is conflicting or insufficient evidence for estimating the amount of a contingent loss, then disclosure is made of the existence and nature of the contingency. A potential loss to an enterprise may be reduced or avoided because a contingent liability is matched by a related counter-claim or claim against a third party. In such cases, the amount of the provision is determined after taking into account the probable recovery under the claim if no significant uncertainty as to its measurability or collectability exists. Suitable disclosure regarding the nature and gross amount of the contingent liability is also made.

Situation 3:

Since the company chooses to self-insure the injury to others caused by itsvehicles is not enough of a basis to accrue a loss that has not occurred at the date of the financial statements. An accrual cannot be made for the amount of insurance premium that would have been paid had a policy been obtained to insure the company against a particular risk. The fact that the company is self-insuring this risk should be disclosed by means of a note to the financialstatement

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