Practice question 1

Randall is currently preparing its financial statements for the year ended 28 February 2019. The board
has met to discuss the following issue:

Some of the products sold by Randall are sold with warranties enabling customers to return faulty goods
within 2 years of purchase. Randall will either repair the product or refund the sales value to the
customer. During the year the sales value of products sold with such warranties totalled E 300,000. Based
on past experience it is anticipated that 20% of these products will be returned under the terms of the
warranty. Of the goods that are returned it is expected that 5% will be beyond repair and Randall will
need to refund the full sales value to the customer. The remaining 95% of returned goods will be able to
be repaired. This will cost Randall, on average, 30% of the items sales price. Some of the goods that have
been sold this year have already been returned under the terms of the warranty. Randall has incurred
costs of E 5,000 in respect of these items. As at 28 February 2018, Randall’s financial statements showed
a provision of E14 000 in respect of warranty costs. This was made up of E 4,000 in relation to goods
sold during the year ended 28 February 2017 and E 10,000 in respect of goods sold during the year ended
28 February 2018. The warranty in respect of items sold during the year ended 28 February 2017 has
expired as at 28 February 2019. During the year ended 28 February 2019, E 3,000 of costs were incurred
in respect of warranty claims made in relation to goods sold in the year ended 28 February 2018.

Solution to Practice question 1

The sale of goods with a warranty represents a past event which gives rise to a present obligation to
either refund or repair the products. It is probable that some of the goods will be returned under the
warranty and Randall is able to use past experience to provide a reliable estimate of the amount of the
obligation. Therefore, under the rules of IAS 37, Randall must make a provision at the year-end in
respect of the costs to be incurred under the warranty. From this year's sales of E 300,000, goods with a
sales value of E 60,000 (20% × E 300,000) are expected to be returned under the warranty. Of these, E
3,000 (5% × E 60,000) will be beyond repair and the full sales value will need refunding to customers.
Of the remaining, E 57,000 (95% × E 60,000) it is anticipated that they can be repaired at a cost of E
17,100 (30% × E 57,000). Thus Randall is expecting to incur total warranty costs of E 20,100 in respect
of goods sold during the year ended 31 March 20X8. E 5,000 of these costs have already been incurred
during the year and therefore Randall should only provide for an additional E 15,100 at the year-end. Of
the opening provision of E 14,000, E 4,000 should be removed since the warranty has expired in relation
to these goods. Of the remaining E 10,000, E 3,000 of costs have been incurred during the year in
relation to these items and therefore Randall are only expecting to incur future costs of E 7,000 in
relation to these items as at 28 February 2019. Therefore the total provision required as at 28 February
2019 is E 22,100 (E 15,100 + E 7,000).

Practice Question 2

Sebastian Co is currently involved in four legal cases, all of them unrelated.

 In Case A, Sebastian Co is suing a supplier for E100, 000.
 In Case B, Sebastian Co is suing a professional adviser for E 200,000.
 In Case C, Sebastian Co is being sued by a customer for E 300,000.
 In Case D, Sebastian Co is being sued by an investor for E 400,000. Sebastian Co has been
advised by its lawyers that the probabilities of success in each case are as follows:
Case Likelihood of Sebastian Co winning the case
A 10%
B 90%
C 98%
D 60%
State the accounting treatment for each of the four cases.
Practice question 2 Solution

Case Comment Accounting treatment

A Contingent gain which is possible Not recognised
B Contingent gain which is possible Disclose as a note
C Contingent liability which is remote Not recognised
D Contingent liability which is possible Disclose as a note

Disclosure of a note would state the nature of the contingency, elements of uncertainty and the financial
effect of the case if the gain/loss should arise.

Practice question 3

1. An entity is taking legal action against its competitor for patent infringement relating to a patent that
had been granted to the entity on one of its products. The outcome of the case is uncertain. However, it is
probable that the court will order the competitor to pay damages to the entity.

2. The facts are the same as in 1 above. However, in this example, it is virtually certain that the court will
order the competitor to pay damages to the entity.

3. The government introduces changes to the income tax system. As a result of those changes, an entity in
the financial services sector will need to retrain a large proportion of its administrative and sales
workforce in order to ensure continued compliance with tax regulations. At the end of the reporting
period, no retraining of staff has taken place.

4. An entity that operates ten petrol stations and owns the land and buildings for those stations chooses
not to purchase fire insurance on those buildings but, rather, to ‘self - insure’ in case of fire loss. The
entity can estimate reliably the statistical probability of the occurrence and amount of expected fire loss
(loss of about E 100,000 once every ten years). The entity wants to recognise a provision of E 10,000 and
related expense each year for the next ten years to reflect its expected loss. The entity argues that the loss
is highly probable, the amount can be measured reliably, and if it had purchased insurance it would
recognise an expense in each reporting period.

Practice Question 3 Solution

1. The entity must disclose the contingent asset because an inflow of economic benefits is probable,
but not virtually certain.
2. The entity must recognise an asset. It is not a contingent asset because the virtual certainty of
receiving benefits removes the contingency.
3. Present obligation as a result of a past obligating event—the tax law change does not impose an
obligation on an entity to do any retraining. An obligating event for recognising a provision (the
retraining itself) has not taken place. Conclusion—the entity does not recognise a provision.
4. The fact that the entity has retained the risk of fire does not create an obligation that is recognised
as a provision. An entity that purchases insurance has paid to transfer its risk to a third party, and
that payment is properly recognised as an asset (prepayment for services) on the date it is made
and then recognised as an expense in profit or loss over the period in which the insurance
coverage is consumed, whether or not there is a fire loss. A fire at one of the stations would be an
event that triggers an impairment test on the fire damaged asset. The impairment test might result
in the recognition of an impairment loss in profit or loss.
Practice Question 4

You are the newly appointed accountant of Gold Mine (Pty) Limited (“Gold Mine”), a gold mining and
exploration company. In the process of preparing the financial statements for year ended 30 June 2018,
you came across some interesting information that the previous accountant didn’t know what to do about.

1. The mine had recently started operations near Klerksdorp for the first time on 1 October 2017, at
which time the environment has been damaged in order to establish the mine. According to the law, Gold
Mine will need to restore the land to its original condition after mining is completed. On 1 October 2017
it was estimated that the cost of rehabilitation (resulting from the damage) would be E 32 million and the
total useful life of the mine was estimated at 20 years. These estimates were unchanged at 30 June 2018.

2. A group of workers were caught mining illegally at one of the older gold mines during the Easter
week-end in 2018. The workers were questioned and they confessed their crimes to Gold Mine. They
offered to repay Gold Mine E 1 million as long as they were not prosecuted. Gold Mine did not agree to
these terms and have chosen to continue with the prosecution. The case was still to appear before the
courts at 30 June 2018, but Gold Mine’s lawyers indicated that it will probably be successful and recover
E 5 million from the workers.

3. Gold Mine received a letter from the Department of Mineral Reserves on 11 July 2018 in which the
company was informed that it is fined for E 6 million resulting from a breach of safety requirements at
the mine, which was observed by the inspectors during their visit to the mine in June 2018. Gold Mine
has decided to appeal the case but unfortunately their chance of success is regarded as low.

An appropriate market interest rate is 9%.

YOU ARE REQUIRED TO:

Prepare ALL the journal entries required for points 1 to 3 above (relating to all the information given in
each case), in order to finalise the financial statements of Gold Mine (Pty) limited for the year ended 30
June 2018. If no journal entries are recognised, reasons need to be provided as well as a brief description
of the required disclosure, if any.
Dates are not required, but you should include a short narration as an explanation giving the reason(s) for
processing the specific journal entry/ies. Ignore closing journal entries.

Practice Question 5

Jive (Pty) Ltd (“Jive”) is a company that manufactures and distributes dancing shoes and other
accessories. It operates mainly in the Western Cape, but has recently started investigating the option of
expanding its operations into Gauteng and Kwazulu-Natal. The directors decided at their directors
meeting during October 2018 to send a management team to each of these provinces in order to establish
if suitable premises could be found for opening new branches.
The following information relates to the reporting period ending 31 October 2018:

1. Jive sold a batch of 550 pairs of shoes to Tango Ltd for an invoice amount of E 258 500 on 3 April
2018. Tango Ltd negotiated to pay within 30 days and receive a 2% settlement discount and Jive
expected that Tango would make use of the early payment terms. Tango paid after 25 days on 28 April
and duly paid the discounted amount.

2. Jive sold a batch of 120 pairs of shoes to Rumba (Pty) Ltd on 14 October 2018 for an invoice amount
of E 54 000. At the date of the sale Jive estimated that 9 pairs of shoes would be returned by Rumba
within the 30 day return period allowed to all customers. At 31 October Jive revised its estimate for the
sales returns to 12 pairs of shoes. Rumba did in fact return 11 pairs of shoes on 12 November, and
received a cash refund. Each pair of shoes had a total cost to manufacture of E 280. This was the only
 sale during the current and prior years where Jive estimated at the date of the sale that inventory would be
returned.

3. Jive offers a 6 month warranty for repairs on all shoes and accessories sold. The warranty does not
cover damage due to negligence on the part of the customer. During the year ended 31 October 2018
repair costs of E 94 000 were incurred (2017: E 88 000). The following balances have been included in
the draft statement of financial position for the year ending 31 October 2018:
2018 20x4
Warranty provision E 39 000 E 47 000

YOU ARE REQUIRED TO:

a) Discuss the correct accounting treatment of the bonus payable to the sales staff of Jive (Pty) Ltd.
Include in your discussion the timing of the recognition in the financial statements of any amounts
relating to the payment of the bonuses.

b) Prepare the provisions note disclosure required in terms of IAS 37 to be included in the financial
statements of Jive (Pty) Ltd for the year ended 31 October 20x5. Comparatives and accounting policy
notes are not required. Assume for answering this section that a provision should be recognised for the
payment of the bonuses.