Question

Below are three independent situations.

1. ABC Ltd is a manufacturer of boats and gives warranties at the time of sale to purchasers of its boats. Pursuant to the warranty terms, ABC Ltd undertakes to make good, by repair or replacement, manufacturing defects that become apparent within three years from the date of sale.
2. ABC Ltd has a number of non-current assets, some of which require, in addition to normal ongoing maintenance, substantial expenditure on major refits/refurbishment at certain intervals or on major components that require replacement at regular intervals.
3. XYZ Ltd is a listed company that provides food to functional centres that host events such as wedding and engagement parties. After an engagement party held by one of XYZ Ltd’s customers in May 2020, 50 people became ill, possibly as a results of food poisoning from products sold by XYZ Ltd. Legal proceedings were commenced seeking damages from XYZ Ltd. XYZ Ltd disputed liability by claiming that the functional centre was at fault for handling the food incorrectly. Up to the date of 30 June 2020 (financial year-end), XYZ Ltd’s lawyers advise that it was probable that XYZ Ltd would not be found liable.

REQUIRED:

Should a liability in the form of a provision be recorded? Briefly justify your decisions.

Answer 1

A provision for liability is provided when there is in the ordinary course of business certain liabiliity is probable
to arise and there is a practical experience of facing the same and certain percentage need to provide against that
loss. In the case of ABC Ltd., giving warranty for repairing or replacement is under the ordinary business activity, so
there is probability of warranty expenses and replacement may be arises. So based on prior experience, providing
provision for expenses for warranty and replancement is correct accounting practice. While making provision for
legal expenses by XYZ Ltd. Is not correct accounting practice as disputed legal case is going on, whiuch is not in the
ordinary course of business and the same should be disclosed as contingent liability.