CA24-3. (Disclosures, Conditional and Contingent Liabilities) Presented below ar
ID: 2719923 • Letter: C
Question
CA24-3.
(Disclosures, Conditional and Contingent Liabilities)
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.
Instructions
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.
(AICPA adapted)
CA24-3.
(Disclosures, Conditional and Contingent Liabilities)
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.
Instructions
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.
(AICPA adapted)
Explanation / Answer
Situation 1 : This contingent liabili is in the possible category. Hence it would suffice to disclose it in the notes to accounts. If however, the management is of the opinion that a it would be prudent to make a provision from profits , it may do so, but a deferred tax asset would be needed to be recognized, since a timing difference would arise with the accounting income being lower than the taxable income. After the lapse of the warranty period, the provision may be written if there are no claims.
Situation 2 The loss is likely to be suffered after the balance sheet date. For the sake of transparency, and inkeeping with the principle of coservatism, a provision for the loss should be made, and necessary disclosures should be given in the notes to accounts.
Situation 3: Firstly, it is a remote contingency at this point in time as no accidents have taken place during the accounting period. Secondly, the impact of the loss that may occur in future cannot even be reasonably estimated. Thirdly the premium that would have to be paid to a third party for covering the loss is of no consequence, as one of the basic principles which form the cornerstone of accounting is the cost concept. Hence, this situation neither warrants the creation of a reserve nor does it need a mandatory disclosure.
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