Question Tag: Provisions

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  • 5 Marks

FR – Nov 2024 – L2 – Q2b – Events After the Reporting Period

Accounting treatment of a court ruling after the reporting period and its impact on Mulba LTD’s financial statements.

As a Trainee Financial Accountant working for Mulba LTD, a technology business, you have been asked by the Financial Controller to provide guidance on how to account for a variety of transactions that took place after the company’s fiscal year ended on December 31, 2023.

Mulba LTD was sued by a customer who was dissatisfied with the quality of a product delivered in June 2023. The court case was heard in late October 2023, but the judgment was delivered on 8 January 2024, ruling in favor of Mulba LTD. The ruling awarded the company legal costs of GH¢20,000 to cover solicitor’s fees.

The legal costs were paid by the customer to Mulba LTD on 12 January 2024.

Mulba LTD was doubtful of winning the case and had previously made a provision in its financial statements for the year ended 31 December 2023 as follows:

Account Debit (GH¢) Credit (GH¢)
Legal Fees – Administrative Expenses 25,000 –
Cost of Sales 35,000 –
Provisions – Current Liabilities – 60,000

Required:
In accordance with IAS 10: Events after the Reporting Period, advise the management of Mulba LTD on the proper accounting treatment of the above issue to ensure that the financial statements are prepared in compliance with IFRS.

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  • 6 Marks

FR – Nov 2024 – L2 – Q2a – Provisions and Contingent Liabilities

Determining the correct accounting treatment for warranty obligations and legal provisions in Kamara LTD’s financial statements.

Kamara LTD manufactures and sells health equipment and has a financial year-end of March 2024. It offers a one-year guarantee for equipment supplied directly to clients. One of the company’s clients is suing the business at the financial year-end for failing to fix equipment within the guarantee period. The company argues that the issue is due to the client disregarding usage instructions, and Kamara LTD believes it is not liable.

Kamara LTD’s lawyer has advised that it is more likely than not that the company will not be found liable. If found liable, the company is estimated to incur legal expenses of approximately GH¢24,000.

Kamara LTD also manufactures another line of equipment sold to wholesalers. During the financial year, it sold 3,200 items of this equipment, which come with a one-year repair guarantee. Based on past experience, 10% of items sold are returned for repairs. Of these returns:

  • 70% require minor repairs at a cost of GH¢64 per item.
  • 30% require significant repairs at a cost of GH¢200 per item.

Required:
Determine the correct accounting treatment to deal with the above issues in the books of Kamara LTD for the year ended 31 March 2024.

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  • 6 Marks

CR – May 2016 – L3 – Q4b – Provisions, Contingent Liabilities and Contingent Assets (IAS 37)

Discuss how the environmental liability for LALUPON Plc, arising from hazardous pollution, should be accounted for in its financial statements.

LALUPON Plc owns a piece of land in a residential area. PONJEB Ltd has leased the piece of land from LALUPON Plc and is using it to store and dispense gas. The Federal government has announced its intention to enact environmental legislation requiring property owners to accept liability for environmental pollution. As a result, LALUPON Plc introduced a hazardous policy and has begun to apply the policy to its properties.

LALUPON Plc has had a report of a gas leakage and subsequent fire outbreak which damaged surrounding properties, but no life was lost. LALUPON Plc has no right of recourse against PONJEB Ltd or its insurance company for the clean-up and compensations to owners of properties destroyed. At April 30, 2014, it is virtually certain that draft legislation requiring a clean-up of the land and payment of compensations to victims will be enacted.

Required:
Discuss how the above events should be accounted for in the financial statements of LALUPON Plc.

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  • 15 Marks

CR – May 2019 – L3 – Q5 – Joint Arrangements (IFRS 11)

Account for a joint arrangement and decommissioning obligations under IFRS 11 and handle the provision for a major overhaul under IAS 37.

a. LPG Plc. is a publicly traded entity on the Nigerian Stock Exchange involved in the production of and trading in natural gas in Nigeria. LPG Plc. jointly owns a gas storage facility with another entity, Tan Oil Nigeria Limited. Both parties extract gas from onshore gas fields in the Niger Delta, which they own and operate independently from each other. LPG owns 55% of the gas storage facility and Tan Oil Nigeria owns 45%. Services and costs are shared between them according to their percentage holding, however, decisions regarding the storage facility require unanimous agreement of the parties. The gas storage facility is pressurised so that the gas is pushed out when extracted. When the gas pressure is reduced to a certain level, the remaining gas is irrecoverable and remains in the gas storage facility until it is decommissioned. The Nigeria law requires the decommissioning of the storage facility at the end of its useful life. LPG Plc. wishes to know how to treat the agreement with Tan Oil Nigeria Limited, including any obligation or possible obligation arising on the gas storage facility.

NB: Ignore accounting for the irrecoverable gas.

b. LPG purchased a major gas plant on 1 January, 2018 and the Directors estimated that a major overhaul is required every two years. The costs of the overhaul are approximately ₦25 million, which comprises ₦15 million for parts and equipment and ₦10 million for labour. The Directors proposed to accrue the cost of the overhaul over the two years of operations up to that date and create a provision for the expenditure.

Required:
Discuss, with reference to International Financial Reporting Standards (IFRS), how LPG Plc should account for the agreement in (a) above (11 marks) and the transactions in (b) for its year ended 31 August, 2018. (4 marks)

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  • 7 Marks

CR – May 2021 – L3 – Q5b – Provisions, Contingent Liabilities, and Discounted Cash Flows (IAS 37)

Calculate provisions and charges for emission modifications in 2015 and 2016 for Gama Plastic Limited.

Gama Plastic Limited owns a number of plastic recycling plants in various parts of the country which supply most of the raw material used by Gama Plastic Limited for its production of household and corporate plastic products.

On December 1, 2015, the directors of Gama Plastic Limited announced publicly that it intends to voluntarily reduce the level of harmful emissions from its recycling plants through modifications of the plants.

The average useful economic life of these plants as of December 31, 2015, was 15 years. Gama Plastic Limited charges depreciation in relation to the recycling plants to cost of sales on a straight-line basis.

The directors believe that while the modifications will be effective from early 2016 onward, the actual cash costs of the modifications will be as follows:

Date Amount (N’000)
December 31, 2016 100,000
December 31, 2017 80,000
December 31, 2018 140,000

No contract was signed until 2016, but Gama Plastic Limited prides itself on its excellent public image and has a well-known reputation for meeting both legal and constructive obligations.

The directors of Gama Plastic Limited believe that it is appropriate to use discounted cash flow techniques and that an appropriate rate would be 10%, with the following discount factors:

Year PV Factor
1 0.909
2 0.826
3 0.751
4 0.683
5 0.620
6 0.564

Required:

Assuming the actual cash cost of the modification is a reliable estimate, calculate the provisions that should be included in the statement of financial position and the charges to the statement of profit or loss of Gama Plastic Limited in respect of the proposal for each of the years 2015 and 2016. (7 Marks)

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  • 7 Marks

CR – May 2021 – L3 – Q5a – Provisions, Contingent Liabilities, and Contingent Assets (IAS 37)

Define provisions and discuss their misuse in creative accounting.

International Accounting Standard (IAS) 37 on Provisions, Contingent Liabilities, and Contingent Assets sets out the principles of accounting for these items. The inappropriate use of provisions has been an area where companies have been accused of manipulating financial statements and engaging in creative accounting.

Required:

What is provisions, and how is it employed by management to engage in creative accounting? (7 Marks)

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  • 15 Marks

AAA – Nov 2012 – L3 – SB – Q2 – Audit of Accounting Estimates and Fair Value Measurements (IAS 36, IFRS 13)

This question discusses the audit steps required to assess the true position of a loan portfolio and the provision for doubtful debts.

Your firm, Alheri & Co, has been appointed to carry out an audit assignment on Barders Bank Limited. The Bank’s year ended 30 September 2010. In the process of carrying out this assignment, it was discovered that no provision was made for doubtful debts. Total loans and advances of N50 billion consisting of 200 customers were found to be at various stages of performance except a N1 billion term loan granted to a Director’s relation’s company on 31 December 2009 to be repaid in N100 million monthly equal instalments commencing from 31 January 2010. Interest was simply agreed at N100,000 per month.

As at the time of this audit, no repayment had been made on this loan.

Required:
a. What audit steps should be taken to ascertain the true position of the loan portfolio? (5 Marks)
b. State the basis and determine the provision that should be made on the loan portfolio. (10 Marks)
(Total 15 Marks)

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  • 1 Marks

AAA – Nov 2011 – L3 – SA – Q2 – Audit of Specialized Industries

Focuses on the key provision auditors should prioritize in insurance company audits.

In conducting the audit of an insurance company, to which ONE of the following should the auditor pay special attention?

  • A. Provision for depreciation
  • B. Provision for unearned interest
  • C. Provision for loan losses
  • D. Provision for outstanding claims
  • E. Provision for general reserve

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  • 15 Marks

CR – Nov 2023 – L3 – SC – Q7 – Provisions, Contingent Liabilities and Contingent Assets (IAS 37)

Evaluate Roman Limited's recognition of provision for emission reduction costs, compute the provision amounts, and explain the profit or loss components.

Roman Limited prepares its financial statements in accordance with International Accounting Standards. On March 16, 2017, Roman Limited made a public announcement of a decision to reduce the level of emission of harmful chemicals from its factories. The average useful life of the factories on March 31, 2017 was 25 years. The depreciation of the factories is computed on a straight-line basis and charged to cost of sales. The directors formulated the proposal for emission reduction following an agreement in principle earlier in the year.

The directors prepared detailed estimates of the costs of their proposals, showing the following expenditures:

  • N60 million on March 31, 2018
  • N60 million on March 31, 2019
  • N80 million on March 31, 2020

All estimates were for actual anticipated cash payments. No contracts were entered into until after April 1, 2017. The estimate proved accurate regarding the expenditure due on March 31, 2018. When the directors decided to proceed with this project, they used discounted cash flow techniques to appraise the proposed investment, with an annual discount rate of 8%. The company has a reputation for fulfilling its financial commitments after it has publicly announced them. Roman Limited has made a provision for the expected costs of its proposal in the financial statements for the year ended March 31, 2017.

In accordance with the provisions of IAS 37 – Provisions, Contingent Liabilities, and Contingent Assets:

Required:
a. Explain the decision of the directors of Roman Limited to recognize the provision in the statement of financial position as at March 31, 2017.
(6 Marks)

b. Compute the appropriate provisions in the statement of financial position in respect of the proposed expenditure at March 31, 2017, and March 31, 2018.
(4 Marks)

Compute the TWO components of the charge to the statement of profit or loss in respect of the proposal for the year ended March 31, 2018. You should explain how each component arises and identify where in the statement of profit or loss each component is reported.
(5 Marks)

(Total 15 Marks)

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  • 30 Marks

AAA – Nov 2017 – L3 – Q5 – Audit Evidence

Evaluate XYZ Bank’s provision for litigation, discuss audit procedures per ISA 501, and prepare litigation disclosure for financial statements.

You are the audit manager for XYZ Bank Limited for the year ended December 31, 2016. The Bank’s Board noted a litigation issue involving a lawsuit from BBB Limited, where the Bank was found liable for a cheque conversion worth ₦2.1 billion. The high court imposed a penalty on the Bank for this amount, which BBB Limited is now claiming.

The Bank has objected to the judgment, appealing to the Court of Appeal, with legal counsel advising that a favorable outcome is expected. The Bank’s litigation-related financial information is as follows:

  • Provision for litigation (recognized in financial statements): ₦96 million
  • Litigation cases as defendant: 50
  • Litigation cases as plaintiff: 10
  • Claims in favor of the Bank: ₦2.7 billion
  • Claims against the Bank (including the ₦2.1 billion case): ₦3.2 billion

Requirements:
a. Discuss FOUR specific considerations under ISA 501 for obtaining audit evidence on litigation provisions.

(5 Marks)
b. Evaluate the adequacy of the litigation provision recognized in the financial statements as at December 31, 2016.

(5 Marks)
c. Prepare a summary disclosure of the litigation status for inclusion in the financial statement notes as at December 31, 2016.

(5 Marks)

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  • 5 Marks

FR – May 2017 – L2 – Q2a – Financial Reporting Standards and Their Applications

Discuss how to account for the cost of site reclamation and the financial effects of an earthquake.

Akakpo Ltd obtained a license free of charge from the government to dig and operate a gold mine. Akakpo Ltd spent GH¢6 million digging and preparing the mine for operation and erecting buildings on site. The mine commenced operations on 1 September 2014. The license requires that at the end of the mine’s useful life of 20 years, the site must be reclaimed, all buildings and equipment must be removed, and the site landscaped. At 31 August 2015, Akakpo Ltd estimated that the cost in 19 years’ time of the removal and landscaping would be GH¢5 million, and its present value is GH¢3 million.

On 31 October 2015, there was a massive earthquake in the area, and Akakpo Ltd’s mine shaft was badly damaged. It is estimated that the mine will be closed for at least six months and will cost GH¢1 million to repair.

Required:

i) Demonstrate how Akakpo Ltd should record the cost of the site reclamation as at 31 August 2015 in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets.
(3 marks)

ii) Explain how Akakpo Ltd should treat the effects of the earthquake in its financial statements for the year ended 31 August 2015 in accordance with IAS 10 Events after the Reporting Period.
(2 marks)

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  • 10 Marks

Aug 2022 – L2 – Q2a – Financial Reporting Standards and Their Applications

Discuss the accounting treatment of specific transactions for Hiba Ltd under IFRS for the year ending December 31, 2021.

Hiba Ltd is a Ghanaian company located in the Bono region, and the directors are unsure of the implications of the International Financial Reporting Standards (IFRSs) on the following specific transactions that took place during the accounting period:

i) On 1 January 2021, Hiba sold one of its mining equipment to Wontumi Ltd for GH¢900,000. The carrying amount of the equipment before the transaction was GH¢500,000, with a remaining useful life of 10 years. On the same day, Hiba entered into a contract with Wontumi Ltd to use the equipment for 5 years, with annual payments of GH¢200,000 payable in arrears. The fair value of the equipment was GH¢800,000, and the interest implicit in the lease was 10% per annum. The sale satisfies the performance obligation criteria in IFRS 15.

ii) On 1 January 2021, Hiba issued 1.5 million shares at GH¢1 each for GH¢1.5 million. Each share is convertible on 31 December 2025 into 2 ordinary shares with a par value of GH¢0.10 each. Interest is payable at 8% per annum. The market interest rate for similar debt without a conversion option was 11%.

iii) On 1 January 2021, Hiba received notice of a lawsuit from an ex-employee claiming unjust dismissal, with an 85% chance of losing the case and being required to pay GH¢1.275 million by 1 January 2022. Based on legal advice, Hiba recorded a provision of GH¢1 million and made no further adjustments. The cost of capital is 9%, and the discount factor at 9% for one year is 0.9174.

Required:
Discuss how the above transactions (i) – (iii) should be treated in Hiba’s financial statements for the year ending 31 December 2021 in accordance with IFRSs. (Show all calculations wherever possible).

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  • 5 Marks

CR – Nov 2018 – L3 – Q2a – Non-current assets held for sale and discontinued operations

Discuss the financial reporting issues for Builsa Ltd regarding the planned closure of a division and the redundancy of employees under IFRS 5.

Builsa Ltd (Builsa) is a listed company that assembles personal computers (PCs), and it is preparing its financial statements for the year ended 31 May 2018. Builsa plans to close down one of its divisions. This division, which is classified as a separate business segment, will cease all of its activities on 31 July 2018. Most of the assets of the business will be redeployed elsewhere in Builsa’s business; however, some smaller items of plant will be sold off or scrapped. Approximately half of the staff of the division will be made redundant, and they were notified of the decision in late May 2018. Customers and suppliers were notified at the same time. The annual 2018 financial statements are scheduled to be released to the markets on 9 August 2018.

Required:
Advise the directors as to the financial reporting issues arising from the above matters and explain the appropriate treatment in Builsa’s financial statements in each case.

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  • 6 Marks

CR – Nov 2021 – L3 – Q2c – IAS 38: Intangible Assets

Advise Zunka Ltd on how to account for the cost of adapting equipment and the provision for potential damages in a legal case for patent infringement.

Zunka Ltd (Zunka) is a private pharmaceutical company in Ghana, which imports medical equipment manufactured under a patent. Zunka subsequently adapts the equipment to fit the market in Ghana and sells the equipment under its own brand name. Zunka originally spent GH¢6 million in developing the know-how required to adapt the equipment, and, in addition, it costs GH¢100,000 to adapt each piece of equipment. Zunka has capitalised the cost of the know-how and the cost of adapting each piece of equipment sold as patent rights.

Zunka is being sued for patent infringement by Sajida Ltd (Sajida), the owner of the original patent, on the grounds that Zunka has not materially changed the original product by its subsequent adaptation. If Sajida can prove infringement, the court is likely to order Zunka to pay damages and stop infringing its patent. Zunka’s lawyers are of the view that the court could conclude that Sajida’s patent claim is not valid.

Sajida has sued Zunka for GH¢10 million for using a specific patent and a further GH¢16 million for lost profit due to Zunka being a competitor in the market for this product. Zunka has offered GH¢14 million to settle both claims but has not received a response from Sajida.

As a result, the directors of Zunka estimate that the damages it faces will be between the amount offered by Zunka and the amount claimed by Sajida. The directors of Zunka would like advice as to whether they have correctly accounted for the costs of the adaptation of the equipment and whether they should make a provision for the potential damages in the above legal case in the financial statements for the year ended 31 March 2021.

Required:

Advise the directors of Zunka on how the above transaction should be accounted for in its financial statements for the year ended 31 March 2021 in accordance with relevant International Financial Reporting Standards (IFRS).

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  • 20 Marks

AAA – Nov 2016 – L3 – Q3 – Planning | Audit Evidence

Identify and explain audit risks, procedures, and evidence related to Kpandu Sika Ltd. for the year ended 31 December 2015.

You are a manager in Amable & Co, a firm of Chartered Accountants, responsible for the audit of Kpandu Sika Limited for the year ended 31 December 2015. Kpandu Sika Limited is a company listed on the Ghana Stock Exchange (GSE) which has been a client of your firm in the past three years. The company manufactures consumer electronic appliances which are then sold to major retail organizations. You are aware that during the last year, Kpandu Sika Limited lost several customer contracts due to cheap imports. However, a new division has been created to sell its products directly to individual customers in Ghana and worldwide via a new website, which was launched on 1 December 2015.

Financial information provided by the Finance Manager is shown below:

STATEMENT OF PROFIT OR LOSS

 

STATEMENT OF FINANCIAL POSITION AS AT

 

EQUITY AND LIABILITIES

NOTES:
i) Kpandu Sika Limited established an equity-settled share-based payment plan for its executives on 1 January 2015. 250 executives and senior managers have received 100 share options each, which vest on 31 December 2015 if the executive remains in employment at that date and if Kpandu Sika Limited’s share price increases by 10% per annum. No expense has been recognized this year as Kpandu Sika Limited’s share price has fallen by 5% in the last six months, and so it is felt that the condition relating to the share price will not be met this year-end.
ii) On 1 July 2015, Kpandu Sika Limited entered into a lease which has been accounted for as a finance lease and capitalized at GH¢19 million. The leased property is used as the head office for Kpandu Sika Limited’s new website development and sales division. The lease term is for five years and the fair value of the property at the inception of the lease was GH¢76 million.
iii) On 30 June 2015 Kpandu Sika Limited’s properties were revalued by an independent expert.
iv) A significant amount has been invested in the new website, which is seen as a major strategic development for the company. The website has generated minimal sales since its launch last month, and advertising campaigns are currently being conducted to promote the site.
v) The long-term borrowings are due to be repaid in two equal installments on 30 September 2016 and 2017. Kpandu Sika Limited is in the process of renegotiating the loan, to extend the repayment dates, and to increase the amount of the loan.
vi) The provision relates to product warranties offered by the company.
vii) The overdraft limit agreed with Kpandu Sika Limited’s bank is GH¢5.7 million.

Required:
a) Using the information provided by the Finance Manager, identify and explain the principal audit risks to be considered in planning the final audit.
(10 marks)

b) State the principal audit procedures which should be performed in respect of the provision for the product warranties offered by the company.
(6 marks)

c) State the principal audit evidence which you would expect to find in respect of the classification of the new lease in terms of IAS 17 Leases (Do not consider the application of the new leasing standard IFRS 16 Leases).
(4 marks)

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