Assignment 6.

1 Contingency (Group Activity)

Related data:
During 2020, Martinah Company was sued by a competitor for 8,000,000 patent infringement.
The legal counsel of the entity advises that the entity shall accrue 3,200,000 as a provision in the financial statements for
the year 2020. Subsequently, on February 28,2021, towards the end of the 2020 reporting period, the Superme Court decided in the favor of the
complainant and ordered the defendant to pay 2,500,000 The entity prepared financial statements for 2020 on January 31, 2021
and BOD approved it on February 20, 2021.

Requirements:
1. How much is the provision on December 31, 2020?
2. What is the related journal entry?
3. How much is the contingency liability and what is the related treatment?

Answer:
1. The answer is ₱3,200,000 because the Supreme Court have decided AFTER the date that the legal councel adviced the entity meaning, the
decision of the Supreme Court that in favors the complainant came after the date of the BOD's approval which is February 20, 2021.

2. Related journal entry

Debit Credit
Loss on contingency 3,200,000
Provision loss on contingency 3,200,000

3. There is no contingent liability to be recognized, as such no disclosure is necessary.

Assignment 6.2 Provision and estimated liability

1. On Novemeber 3, 2020, Minorka Bus Company had an accident. On January 12, 2021, the entity received a notice of lawsuit for 7,000,000
damages for personal injuries suffered by the passengers.
The entity's legal counsel believed it is probable that Minorka will pay the complainant between 2,000,000 and
5,000,000 . The possible outcomes are equally likely.
How much is the provision on December 31, 2020?

Solution:
2,000,000 50% 1,000,000
5,000,000 50% 2,500,000
₱ 3,500,000.00

2. In 2020, Sushmita Company was sued by a competitor.

The lawyer believes there is a chance of 75% that the court will not dismiss the case and the entity will incur and outflow of benefits. If the
court rule in favor of the complainant, the lawyer believed that a 75% chance of paying 3,000,000 damages and a
25% chance of paying 1,500,000 . Other amounts of damages are unlikely.
There is no indication that the claimant will settle out of court.
A risk adjustment of 10% is considered to appropriately reflect uncertainties in the cash flow estimates.
The court is expected to rule in late December 2021.
The discount rate is 12% and the PVF of 1 is 0.89
How much is the provision on December 31, 2020 (round-off answer to the nearest peso value)?

Suggested solution:
Amount Probability % Chances % Expected Value
3,000,000 75% 75% 1,687,500
1,500,000 75% 25% 281,250
Total expected value (Weighted probabilities) 1,968,750
Risk adjustment 1,968,750
10% 196,875
Adjusted expected value (Undiscounted cash flows) 2,165,625
PVF 0.89
Provision, December 31, 2020 ₱ 1,927,406.25

3. In 2020, Dublin Company began selling new line of products that carry a two year warranty against defects.
Based upon past experience with other products, the entity estimated warranty costs as a percentage of peso sales.
First year of warranty 2%
Second year 5%

2020 2021
Sales 5,000,000 7,000,000
Actual warranty cost 100,000 300,000

How much is the estimated warranty liability at December 31, 2020?

Suggested solution:
Sales - 2020 5,000,000
Warranty percentage - total 7%
Warranty expense, 2020 350,000
Less: Actual warranty cost - 2020 100,000
Estimated warranty liability, December 31, 2020 ₱ 250,000.00

Estimated warranty liability, January 1, 2021 250,000

Estimated warranty liability for 2021 sales:
Sales - 2021 7,000,000
Warranty percentage - total 7%
Warranty expense, 2021 490,000
Less: actual warranty cost - 2021 300,000 190,000
Estimated warranty liability, December 31, 2021 ₱ 440,000.00