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F7 Provision

RRoy11y ago
hello Mike hope all is well i have a quick question. The question is pasted below: "Skeptic has two potential liabilities to assess. The first is an outstanding court case concerning a customer claiming damages for losses due to faulty components supplied by Skeptic estimated outcome of this liability is: Court case Product warranty claims: 10% chance of no damages awarded 65% chance of damages of $4 million 25% chance of damages of $6 million Advise, and quantify where possible, how the above should be treated in Skeptic’s financial statements for the year ended 31 March 2014" The solution proposed by ACCA for this is: "For the court case the most probable single likely outcome is normally considered to be the best estimate of the liability, i.e.$4 million. This is particularly the case as the possible outcomes are either side of this amount. The $4 million will be an expense for the year ended 31 March 2014 and recognized as a provision" however i have done this differently. Like i have specified that Skeptic should recognize this as contingent liability where the estimated outcome of this liability is 10% and 25% and where it is 65%, it should make a provision of (0.65*4000,000) = 2600,000. is my method acceptable? can you explain why its 4m as provision in the solution by acca and not 2.6m? the reason i did multiply 65% to 4m is because thats how it was done in emily wolf text book thanks
MMikeLittleTutor11y ago#1
Where the situation covers a series of potential claims, lie in a warranty situation, then the weighted average / expected value method is used. There's an example of that in the P2 opentuition notes called Tamara and her micro-wave ovens. But where the situation is a one-off event, like the court case in the last exam, the correct calculation is to show the "most likely" at its full value. Conceptually, if you are to take 65% of $4m, why have you not also taken 25% of the $6m. THAT would have been the correct approach IF it had been such as a warranty claim provision This is concisely and precisely illustrated in the IASPLUS website article on IAS 37 Sorry to be the bearer of bad news :-(
RRoy11y ago#2
hello Mike thanks for your reply i understand about the weighted avg approach and i have done exactly that for the 2nd part of this question. however in the first part (that deals with court case) i did multiply 25% of 6million and advised skeptic to show it as contingent liability. for (65% chance of damages of $4 million) i advised skeptic to show it as provision since it was over 50%. i did multiply 65% to 4m
MMikeLittleTutor11y ago#3
Yes, but in a one-off situation, you should provide for the full (most likely) amount Again, sorry
RRoy11y ago#4
ok thanks mike
MMikeLittleTutor11y ago#5
You're welcome
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