- 20 Marks
Question
You are the Financial Controller of Fidipote PLC, a bottling company with diverse products. The accountant responsible for preparing the 2020 annual financial statements is considering the accounting treatment of the following and has approached you for guidance:
a. On December 31, 2020, Fidipote PLC has a litigation proceeding involving a customer claiming damages in the sum of ₦50 million because she had allegedly been injured when drinking one of the company’s products. She had claimed that the company bottled a sharp object inside the content of the product which she swallowed and had to be operated upon in order to remove the object. Fidipote PLC is disputing the claim, maintaining that any injury was due solely to negligence on the part of the customer. As at December 31, 2020, the case was yet to be decided.
(8 Marks)
b. Fidipote PLC signed a ten-year lease agreement on a property requiring an annual payment of ₦5 million in advance on January 1, 2016. The property was used over the years as a Cinema Hall. As a result of the COVID-19 pandemic and the lockdown during 2020, the consequent long closure of the hall made patronage of cinema shows financially unsustainable. Fidipote PLC discovered that it has no further use of the building. It is not possible to sub-lease the building to another tenant, and remodeling cannot be done due to certain provisions of the lease agreement. As at December 31, 2020, the present value cost of outstanding lease installments amounted to ₦22.5 million.
(6 Marks)
c. The Managing Director made a proposal that the Fidipote brand name is unique and of significant market persuasion and should, therefore, be included as an asset in the financial statements. Due diligence, including market research by a certified consultant, has been done on this proposal. A valuation of ₦250 million was determined to be included in the financial statements as at December 31, 2020.
(6 Marks)
Required:
Explain how the above information, a to c, should be presented in the financial statements of Fidipote PLC for the year ended December 31, 2020.
Answer
a. Litigation Proceeding (₦50 Million Claim):
- The relevant standard for this treatment is IAS 37 – Provisions, Contingent Liabilities, and Contingent Assets.
- Contingent liabilities represent potential obligations that may arise depending on the outcome of uncertain future events beyond the entity’s control.
- Since the litigation is unresolved as of December 31, 2020, Fidipote PLC’s liability is contingent upon the outcome of the case, which remains uncertain.
- Disclosure: The litigation should be disclosed as a contingent liability in Fidipote PLC’s financial statements, describing the nature of the claim, the amount sought by the customer (₦50 million), and the company’s stance on the issue (disputing the claim due to alleged negligence by the customer).
- No Provision Required: As the probable outcome and payment cannot be reliably measured, a provision should not be recognized at this stage; instead, the disclosure should appear in the notes to the financial statements
b. Lease Agreement (₦22.5 Million Onerous Contract):
- The relevant accounting treatment is based on IAS 37 for onerous contracts, which are contracts where the unavoidable costs of fulfilling the contract exceed the expected economic benefits.
- Given that the Cinema Hall lease became economically unviable due to COVID-19 and the inability to sub-lease or remodel the property, this lease qualifies as an onerous contract.
- Provision Requirement: Fidipote PLC should recognize a provision for the present value of the remaining lease obligations, calculated at ₦22.5 million as of December 31, 2020.
- Journal Entry:
- Dr Provision for Lease Expense (SOCI) ₦22.5 million
- Cr Provision for Lease Liability (SOFP) ₦22.5 million
- This provision reflects Fidipote’s unavoidable cost associated with the lease, recognizing the financial burden due to the pandemic’s impact on Cinema Hall operations
c. Brand Name Valuation (₦250 Million):
- The accounting treatment for the brand name falls under IAS 38 – Intangible Assets.
- Although the Fidipote brand name is valuable and recognized in the market, it is an internally generated intangible asset, which IAS 38 generally prohibits from being recognized in the financial statements.
- Non-Recognition: The valuation of ₦250 million cannot be recognized as an asset on Fidipote’s balance sheet because internally generated brands do not meet the recognition criteria for reliability in measurement.
- Disclosure: The brand valuation can be disclosed in the notes to the financial statements, providing details about its estimated market value as assessed by an external consultant. This disclosure would inform stakeholders of the brand’s market significance without violating IAS 38’s restrictions
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