RBA1

Issues in Accounting Practices

Assignment #1
Provision, Contingent Liabilities and Assets

1. The retail business has a policy of refunding purchases by dissatisfied customer, even
though it is under no legal obligation to do so. Its policy of making refunds is generally
known.

Should a provision be made at the year end?

2. An entity sells goods with a warranty covering customer for the cost of repairs required
within the first 12 month after purchase. Past experience suggests that 95% of goods sold
will not require a warranty repair.

Should a provision be made for warranty repairs?

3. An entity has a policy of only carrying out work to rectify damage cause to the
environment when it is required by local law to do so. For several years the entity has been
operating an oil rig that causes such damage in a country that did not have legislation in
place requiring any rectification.

A new government has now been elected in that country and at the reporting date, has just
brought in legislation requiring rectification of environmental damage. The legislation will
have retrospective effect.

Required.

Explain whether a provision should be recognized.

4. CEG has ten year left to run on the lease of property that it has recently vacated. The
present value of the future rentals at the reporting date is $50,000. The cost of termination
the lease early is 55,000.

How should the above scenario be accounted for?

5. On 14 June 20X2 a decision is made by the board of directors of KCM to close down a
division and a detail plan is drawn up. At the year end of 30 June 20X2, no announcement
has been made in respect of the closure and no steps have been taken to implement the
decision. The expected costs of closing the division are $750,000.

Should a provision be made for the expected costs of closing the division?
6. Entity A is suing entity B in respect of losses sustained from faulty goods supplied by
entity B. Entity A’s lawyers are unwilling to state the likelihood of the claim being
successful.
Entity B’s lawyers have told entity B to expect to have to pay damages but are unable at
present to provide a reliable estimate of the amount payable.

How would each entity account for the above scenario?

7. ES operates is the oil and gas industry and publishes an environmental and social report to
demonstrate its corporate social responsibility. It is partly responsible for a recent oil leak
causing damage to local environment and is planning to voluntarily contribute to the costs
of the clean-up, although it is under no legal obligation to do so. It anticipates the cost to be
$500,000 but this is not certain.

How should the above scenario be accounted for?