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X company received a claim 100000$ from customer for providing poor quality goods which have damaged customer’s plant and equipment and X company’s lawyers have stated that there is a 20% chance that X company will successfully defend the claim.
I think all of amount will be transferred to provision account. in test there is a answer that shows—- X company provide for the expected cost of claim of 100000$. is this answer true??and is this answer also is the same as provision?
Making a provision is the same as making an accrual – we call it a provision when we are not certain about the amount and/or the timing.
Here there is a contingent liability, and since the probability of having to pay the $100,000 is 80% then according to IAS 37 it is “probable” and therefore we must provide (effectively accrue).
I really do suggest that you watch the free lecture on IAS 37 where I go through the rules.
Hi , can you please help me with the following:
Which of the following should be recorded as a provision?
A: Legislation which will come into force in the next financial year requires a company to improve its safety equipment. The company wishes to provide for the cost of the improvements in the accounts in the current financial year.
B: The company has caused environmental damage and the law requires that they pay to restore the site.
I answered B but the answer is A.
Can you please help me understand.
Thanks a lot
A is correct, because the question actually says that they wish to provide (a provision). They call it a provision because although they know that the are going to have to pay something, they don’t yet know the exact amount or exactly when.
B is wrong because here they are definitely going to have to pay (and they should be able to calculate how much it will cost) so they will make an accrual rather than a provision.(The entries are effectively the same – we just call it an accrual when we are certain, and a provision when we are not certain of the amount etc..)
Thanks a lot for the clear explanation.
I love your site and spend hours on it, so helpful, so insightful
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