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ACCOUNTING TREATMENT
You have been asked to advise on the appropriate accounting treatment for the following situations arising in the books of various companies. The year end in each case can be taken as 31 December 20X4 and you should assume that the amounts involved are material in each case.
(a) At the year-end there was a debit balance in the books of a company for GH¢15,000, representing an estimate of the amount receivable from an insurance company for an accident claim. In February 20X5, before the directors had agreed the final draft of the published accounts, correspondence with lawyers indicated that GH¢18,600 might be payable on certain conditions.
(b) A company has an item of equipment which cost GH¢400,000 in 20W8 and was expected to last for ten years. At the beginning of the 20X4 financial year the book value was GH¢280,000. It is now thought that the company will soon cease to make the product for which the equipment was specifically purchased. Its recoverable amount is only GH¢80,000 at 31 December 20X4.
(c) On 30 November, a company entered into a legal action defending a claim for supplying faulty machinery. The company’s solicitors advise that there is a 20% probability that the claim will succeed. The amount of the claim is GH¢500,000.
(d) An item has been produced at a manufacturing cost of GH¢1,800 against a customer’s order at an agreed price of GH¢2,300. The item was in inventory at the year-end awaiting delivery instructions. In January 20X5 the customer was declared bankrupt and the most reasonable course of action seems to be to make a modification to the unit, costing approximately GH¢300, which is expected to make it marketable with other customers at a price of about GH¢1,900.
(e) At 31 December, a company has a total potential liability of GH¢1,000,400 for warranty work on contracts. Past experience shows that 10% of these costs are likely to be incurred, that 30% may be incurred but that the remaining 60% is highly unlikely to be incurred.
Required
For each of the above situations outline the accounting treatment you would recommend and give the reasoning of principles involved. The accounting treatment should refer to entries in the books and/or the year-end financial statements as appropriate.
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Kumasi Ltd is preparing its financial statements for the year ended 30 September 20X4. The following matters are all outstanding at the year end.
(1) Kumasi Ltd is facing litigation for damages from a customer for the supply of faulty goods on 1 September 20X4. The claim, which is for GH¢500,000, was received on 15 October 20X4. Kumasi Ltd’s legal advisors consider that Kumasi Ltd is liable and that it is likely that this claim will succeed. On 25 October 20X4 Kumasi Ltd sent a counter-claim to its suppliers for GH¢400,000. Kumasi Ltd’s legal advisors are unsure whether or not this claim will succeed.
(2) Kumasi Ltd’s sales director, who was dismissed on 15 September, has lodged a claim for GH¢100,000 for unfair dismissal. Kumasi Ltd’s legal advisors believe that there is no case to answer and therefore think it is unlikely that this claim will succeed.
(3) Although Kumasi Ltd has no legal obligation to do so, it has habitually operated a policy of allowing customers to return goods within 28 days, even where those goods are not faulty. Kumasi Ltd estimates that such returns usually amount to 1% of sales. Sales in September 20X4 were GH¢400,000. By the end of October 20X4, prior to the drafting of the financial statements, goods sold in September for GH¢3,500 had been returned.
(4) On 15 September 20X4 Kumasi Ltd announced in the press that it is to close one of its divisions in January 20X5. A detailed closure plan is in place and the costs of closure are reliably estimated at GH¢300,000, including GH¢50,000 for staff relocation.
Required
State, with reasons, how the above should be treated in Kumasi Ltd’s financial statements for the year ended 30 September 20X4
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Under IPSAS 19: Provisions, Contingent Liabilities and Contingent Assets, the authority needs to account for the cancellation of contracts, the legal case, the court’s decision, and the potential revision of the contract amount.
Required:
Determine whether provisions should be made for the court award and contract revision, calculate the expected value of the revised contract amount, and outline the disclosures required under IPSAS 19.
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