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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 millionAdvise, 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
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 🙁
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
Yes, but in a one-off situation, you should provide for the full (most likely) amount
Again, sorry
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