Accounting Treatment for Contingent Liabilities

This assignment addresses accounting for contingent liabilities using real-world examples. It delves into the definitions and treatments of both contingent liabilities and provisions, specifically examining a sale agreement with a maintenance obligation and a refund contingency. The document emphasizes the importance of adhering to Australian Accounting Standards (AASB 137) for accurate financial reporting.

Running head: TAX
Tax
Name of the Student:
Name of the University:
Authors Note:

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Magenta and Associates
718 Gelong Street
MELBOURNE VIC 300
20 January 2018
Mr Chrstopher Sampson
Managing Director Beachlife Ltd.
Dear Mr Christopher
Magenta and Associates continuously perseveres in providing its clients with relevant,
accurate and quality solutions faced by the clients. In response of your email this letter is
being written to provide you with all the relevant and correct solution for the issues faced by
your company in respect of accounting treatments and disclosures to be given. We are
hopeful that the issues will be eliminated with the application of the suggested solutions.
The implication of accounting treatment is immense as the financial statements are
used by the shareholders and creditors. The application of correct and appropriate accounting
treatment as laid down in the standards is necessary because only by adhering to the proper
accounting treatment, the financial statements of the company will be able to show the true
and fair view of the entity’s financial position and performance (Taylor & Richardson, 2017).
The main purpose of adopting the changes is to follow the requirements as given out in
different paragraphs of AASB 137.

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As per the guidelines of AASB 137 the meaning of the words contingent liability and
provision have been clearly given out. In order to understand the implication and treatment of
these items the definition given in the accounting standard is discussed hereafter. According
to the guidelines of AASB 137 a provision is a liability whose timing and amount is
uncertain. The contingent liability is also explained in the accounting standard AASB 137.
The definition of the contingent liability is that the obligation that may arise in future due to
the past event of the entity and its existence is dependent on happening or non-happening of
an uncertain future event which may not be wholly in the control of the management
(Sugiyama & Islam, 2016). The following reason for which the present obligation arising out
of past events has not been recorded are that there are very remote chances of an outflow of
resources embodying economic benefits to take place for the settlement of the obligation. In
addition to this the amount cannot be reliably estimated based on the available information.
The relevant implication and accounting treatment of the items have been discussed while
explaining the issues.
Pending court case:
The first issue faced by your company is related to the claim filed against it by its
competitors for patent infringement. It is mainly concerned about the disclosure requirement
and accounting treatment of the claims made by the competitors. A compensation of $87
million has been claimed by the competitors. A hearing has been scheduled on 31st July 2017
for the same. It has been estimated that there is a 30 % chance that the company will be found
guilty and will have to pay the full compensation. Other estimates have also been made
regarding other possible scenarios. There is a 60 % chance that the company will pay $50
million and a 40 % chance that the company will pay $30 million. The financial statements
have already been approved and there is no current obligation that has arisen out of past
events (Tran & Zhu 2017). This violates the recognition criteria of a provision as laid down

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in AASB 137. Hence, no provision has to be recorded in the financial statements. As per Para
86 of AASB 137 a contingent liability should be recorded unless the probability of an
outflow of resources embodying economic benefits is very remote. In the present the chances
of payment or outflow is not remote hence, the company , must disclose the possibility of
losing the case as a contingent liability in the notes to accounts of the financial statements
(AASB, 2014).
Appropriate accounting treatment for the sale agreement:
As per the facts of the issues the company has made sale of equipment on 12th December
2017, the delivery and payment for the same was scheduled for 22nd December 2017 and 31st
December respectively. A maintenance clause has been included in the agreement according
to which the company have to provide maintenance services for the equipment for the next 12
months from the date of delivery failing which the customer will receive 15 % refund from
the company. As per our suggestion the following accounting treatment should be done by
the company (Jeyaretnam, 2017). The company should record the sale in the books of
accounts on the date of agreement of sale itself due to absence of any uncertainty over the
delivery of the goods and the payment to be received in its respect. Hence the company
should recognise the sale on 12th December 2017. A provision in respect of the maintenance
has to be made as it is a present obligation of the company arising out of past events (sale of
equipment) by debiting maintenance account and crediting provision for maintenance account
(Jin et al., 2015). The maintenance account will be transferred to profit and loss account and
provision for maintenance account will be transferred to the balance sheet of the company. A
contingent liability has to be recorded in respect of the refund amount in the notes to accounts
of the financial statements of the company as the amount is dependent upon the happening
and non-happening of an uncertain future event (quality of service provided by the company
to the customer in the future).

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We would like to highlight the importance of the accounting treatment suggested by us
for the company. In abiding these accounting treatments the company will be able to ensure
that it is maintaining the reliability of the information as reflected in the financial statements
of the company. In addition to providing the solutions for the issues faced by the company we
have endeavoured to provide clear and reliable clarification about the reasons of such
changes suggested by us. The standards laid down by the Australian statute, specifically
AASB 137 has been referred to establish the meaning of the terms and the justifiable
accounting treatment of the same. We are hoping that through this letter we have been able to
create value for your company. We are eagerly looking forward to serving you again.
In case of any queries or doubts please don’t hesitate in contacting me.
Your Sincerely
Lisa Magenta
Manager
Magenta and Associates

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Reference
AASB, C. A. S. (2014). Business Combinations. Disclosure, 66, 77.
Jeyaretnam, T. (2017). Emerging risk: Mine closure and rehabilitation. AusIMM Bulletin,
(Dec 2017), 24.
Jin, K., Shan, Y., & Taylor, S. (2015). Matching between revenues and expenses and the
adoption of International Financial Reporting Standards. Pacific-Basin Finance
Journal, 35, 90-107.
Sugiyama, S., & Islam, J. (2016). Empirical findings from the reconciliations in the first IFRS
compliant reports prepared by Japanese-owned subsidiaries in Australia. Advances in
Accounting, 35, 143-158.
Taylor, G., & Richardson, G. (2014). Incentives for corporate tax planning and reporting:
Empirical evidence from Australia. Journal of Contemporary Accounting &
Economics, 10(1), 1-15.
Tran, A., & Zhu, Y. H. (2017). The impact of adopting IFRS on corporate ETR and book-tax
income gap. In Australian Tax Forum (Vol. 32, No. 4, p. 757). Tax Institute.