Question

JHI Engineering Pte Ltd (“JHI”) has been served a legal notice on 15 November 20Xl by the local building authority to fit smoke detection and sprinkling system in its factory on or before 31 July 20X2 failing which the company would face a fine of $20,000. The cost of fitting such a system is estimated at $190,000.

Examine and explain how JHI should treat this in its financial statements for the year ended 31 December 20X1.

Answer 1

This is a case where an entity need to carry out expenditure to operate in a particular way in the future basis legal requirements. However, the entity can avoid the future expenditure by its future actions i.e by fiting the requisite smoke detection and sprinkling system in its factory in future, hence it has no present obligation for that future expenditure.

Hence, No provision is recognized in the financial statements for the year ended 31 December 20X1, because there is no present obligationfor the future expenditure. It is presumed that the entity can avoid the future expenditure by changing the method of operations. However,disclosure of the event is required in the financial statements for the year ended 31 December 20X1.