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I have some problems with provision and materiality.
One company has net profit before tax of £1.1 billion, and they set materiality levels equally 5% of net profit before tax.
Company’s lawyer says that: Company has to pay £120,000 for legal claim, and they just has only a 10% chance of recovering any of the loss from legal claim.
What amounts of provision that the company should set in financial statement?The materiality is: £1.1.5% =£ 55,000
However, if they set the provision of 120,000. It is not following the materiality or if they set the provision of £108,000 (120000.90%). It is also not following the materiality.So What can I do now?
Do you mean:
5% x £1.1 Million = £55,000
or
5% x £1.1 Billion = £55 million?
What do you mean “is not following the materiality”?
In the circumstance you describe £120,000 is the best estimate of the liability – and this is the amount that should be provided for – i.e. Dr Profit or loss and Cr Liability.
The 10% potential recovery is separate – and because it is only possible (<50%) rather than probable (>50%) – it won’t even be disclosed as a contingent asset. It would NEVER be appropriate to consider 90% in this scenario.
If net profit is £1.1 M: £120k is 10.9% of net profit and therefore material. Failure to make a provision would therefore be grounds for a modified opinion “except for” material misstatement.
If net profit is £1.1 B: £120k is 0.01% of net profit and clearly trivial. Neither management nor the auditor will be interested in this matter.
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