- 15 Marks
Question
The following information pertains to Eko Exports Limited (EEL) for the financial year ended December 31, 2016:
- A customer who owed ₦1 million was declared bankrupt after his warehouse was destroyed by fire on February 10, 2017. It is expected that the customer would be able to recover 50% of the loss from the insurance company.
- An employee of EEL forged the signatures of directors and made cash withdrawals of ₦7.5 million from the bank. Of these, ₦1.5 million were withdrawn before December 31, 2016. Investigations revealed that an employee of the bank was also involved, and under a settlement arrangement, the bank paid 60% of the amount to EEL on January 27, 2017.
- EEL has filed a claim against one of its vendors for supplying defective goods. EEL’s legal consultant is confident that damages of ₦1 million would be paid to EEL. The supplier has already reimbursed the actual cost of the defective goods.
- A suit for infringement of patents, seeking damages of ₦2 million, was filed by a third party. EEL’s legal consultant is of the opinion that an unfavorable outcome is most likely. Based on past experience, he has advised that there is a 60% probability that the amount of damages would be ₦1 million and a 40% likelihood that the amount would be ₦1.5 million.
Required:
Advise EEL about the amount of provision that should be incorporated and the disclosures that are required to be made in the financial statements for the year ended December 31, 2016.
Total: 15 Marks
Answer
Eko Exports Limited (EEL)
- Bankrupt Customer
- The debt owed by the customer existed at the reporting date, but the customer’s inability to pay was only evident on February 10, 2017, when they were declared bankrupt after the fire incident. According to IAS 10 (Events after the Reporting Period), this qualifies as a non-adjusting event.
- Disclosure Required:
- Nature of the Event: Description of the fire incident and subsequent bankruptcy.
- Financial Effect Estimate: Since 50% is recoverable from insurance, disclose the remaining 50% (₦500,000) as a note regarding the incident’s financial impact.
- Employee Fraud
- The ₦1.5 million withdrawn before year-end is an adjusting event, as it existed at the reporting date. Since 60% has been recovered (₦1.5 million x 60% = ₦0.9 million), only ₦0.6 million should be recognized in the financial statements.
- The remaining ₦6.0 million withdrawn post-year-end is a non-adjusting event.
- Disclosure Required:
- Nature of Event: Details of the employee fraud.
- Gross Contingency: ₦6.0 million.
- Recovered Amount: ₦3.6 million (₦6.0 million x 60%).
- Claim against Vendor
- EEL should not recognize the contingent gain until it is realized, as per IAS 37 (Provisions, Contingent Liabilities, and Contingent Assets).
- Disclosure Requirements (if probable and material):
- Contingency Asset Nature: Description of the claim for damages due to defective goods.
- Estimated Financial Effect: ₦1 million, as the probable claim amount.
- Patent Infringement Suit
- EEL should provision for the expected amount, which is ₦1.2 million (₦1 million x 60% + ₦1.5 million x 40%), based on IAS 37, as there is a probable outflow due to a present obligation and a reliable estimate.
- Disclosure Requirements:
- Nature of Contingent Liability: Details of the infringement claim.
- Contingency Amount: ₦1.2 million.
- Uncertainty: Indicate any uncertainties related to amount or timing of potential outflows.
- Tags: Bankruptcy, Contingent Liabilities, Forgery, Legal claims, Provisions
- Level: Level 3
- Topic: Impairment of Assets (IAS 36)
- Series: NOV 2017
- Uploader: Dotse