Topic 02: Provision & Contingencies

Expected question(s):
1. What is the amount of expense from lawsuit for the year?
2. What is the lawsuit payable at year end?
3. What is the amount of premium expense for the year?
4. What is the premium payable at year end?
5. What is the amount warranty expense for the year?
6. What is the warranty payable at year end?

PROVISIONS
• Liability with uncertain time and/or amount
• Recorded as liability
• Both measurable and probable (or higher)
• No disclosure to F/S is required
CONTINGENCIES
• Liability with uncertain time and/or amount
V.S. • Not recorded as liability
• (a) measurable but not probable
(b) probable but not measurable
(c) not measurable and not probable
• If possible – disclosure to F/S is required
• If remote – no disclosure to F/S is required

Virtually certain – Above 90% chance

Probable – Above 50% chance

Possible – 50% and below chance

Remote – 5% and below chance

1) What is the amount of expense from lawsuit for the year?

2) What is the lawsuit payable at year end?

Answer: Measurement of liability and expense:

FIRST PRIORITY – Actual amount, if known before the F/S issuance date.

SECOND PRIORITY – Best estimate made by the company (company’s lawyer).

THIRD PRIORITY – Midpoint if a range of estimate is given [(highest point + lowest point) / 2].

FOURTH PRIORITY – Expected value, if multiple outcomes is given [total of (outcome x probability %)].

(Outcome 1 x Probability %) = X
(Outcome 2 x Probability %) = X
(Outcome 3 x Probability %) = X
Expected value X

WITH INSURANCE COVER LIABILITY – Best estimate made by the company (company’s lawyer).

Rule for the liability: Rule for the expense:

Rule 1: The liability is not affected (as is).
No offsetting of lawsuit liability and
receivable (claims from) insurance
company.
Rule 1: If no deductible clause, expense is ZERO
Rule 2: If with deductible clause, expense is equal to
the deductible clause.
Best answer is to offset the expense from lawsuit
and the gains from insurance claims. Regardless,
the deductible clause will be paid and should be
expensed.

Intermediate Accounting 2 | Bernadette L. Baul Page 1 of 5

3) What is the premium expense for the year?
4) What is the premium payable at year end?

Answer:

Step 1: Compute for the premium expense, in units.

Total number of coupons (proof of purchase, bottle caps, etc.) X

Times: Percentage of expected redemption x%
Divide: Number of coupons required to redeem one premium X
Premium expense, in units (premiums to be distributed for the current year’s sale) X

Step 2: Compute the net cost of each premium.

Cost of each premium X

Add: Cost to distribute the premiums X
Less: Cash demand from customers redeeming the premiums X
Net cost of each premium X
Step 3: Compute for the premiums distributed, in units.

Alternative 1
Actual number of coupons redeemed
Divide: Number of coupons required for 1 prem.
Number of premiums distributed
X X
X X
X X
Premiums distributed X

Step 4: Compute for the premium expense and premium payable by preparing the table below:

(Step 2)
In units Net cost In Peso
Beginning premium payable X X X
Add: Premium expense (Step 1) X X X
Less: Premium distributed (Step 3) X X X
Ending premiums payable X X X

5) What is the warranty expense for the year?

6) What is the warranty payable at year end?

Answer:

Step 1: Compute the amount of warranty expense.

Total sales during the period X

Times: Total expected warranty cost during the warranty period x%
Warranty expense X

Step 2: Compute the amount of warranty payable.

Beginning warranty payable X

Add: Warranty expense (Step 1) X
Less: Actual warranty expenditure during the year X
Ending warranty payable X

Intermediate Accounting 2 | Bernadette L. Baul Page 2 of 5

Alternative way:

Cumulative sales (from the very beginning up to date of question) X

Times: Total expected warranty cost during the warranty period x%
Cumulative warranty expense X
Less: Cumulative actual warranty expenditure (from beginning to question date) X
Ending warranty payable X

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Intermediate Accounting 2 | Bernadette L. Baul Page 3 of 5