Provision, Contingent Liability and Subsequent Event Judgements
On 15 November 20X5, a customer sued Vantage Engineering Ltd for BDT 6,000,000, alleging defects in a component supplied in 20X4. At 31 December 20X5, the company's lawyers advise that it is probable that Vantage will be found liable, and that the best estimate of the loss is BDT 4,000,000, with a range of BDT 3,000,000 to BDT 5,000,000. On 20 February 20X6, before the financial statements are authorised for issue on 15 March 20X6, the court awards BDT 4,500,000 against Vantage. Separately, on 10 January 20X6, a fire destroyed a distribution depot with a carrying amount of BDT 7,000,000; insurance will cover BDT 5,000,000. The finance director wants to recognise the BDT 6,000,000 claim as a provision, ignore the court award, and treat the fire as a non-adjusting event with no disclosure.
1. Determine the provision at 31 December 20X5 and explain why the claimed amount is not used.
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A provision is recognised because a present obligation exists from a past event (supplying defective components), an outflow is probable, and the amount can be reliably estimated. The provision is measured at the best estimate of the expenditure required to settle the obligation, which is BDT 4,000,000, not the BDT 6,000,000 claimed. The claim is the amount sought, not the expected cost.
Where a range of outcomes exists, the best estimate within the range is used; BDT 4,000,000 is the midpoint and the lawyers' best estimate. The BDT 3,000,000 to BDT 5,000,000 range supports reliability but does not change the point estimate. The FD's proposal to provide BDT 6,000,000 overstates the liability and the expense. The provision is presented as a current liability unless settlement is expected beyond twelve months.
2. Explain the effect of the court award and the fire, and state the required treatment and disclosure.
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The court award of BDT 4,500,000 on 20 February 20X6 is an adjusting event: it provides evidence of conditions that existed at the reporting date (the obligation and its amount). The provision is adjusted to BDT 4,500,000, increasing the expense by BDT 500,000 in the 20X5 financial statements. The FD's proposal to ignore it is wrong.
The fire on 10 January 20X6 is a non-adjusting event: it concerns conditions that arose after the reporting date. The depot's carrying amount is not adjusted. However, the event is material: the uninsured loss is BDT 2,000,000 and the depot is a significant operating asset. Disclosure is required of the nature of the event and an estimate of its financial effect, so the FD's proposal of no disclosure is rejected.
Summary: provision increased to BDT 4,500,000; fire not adjusted but disclosed with the BDT 2,000,000 uninsured exposure.