ACCA Applied Knowledge · Financial Accounting · Disclosure notes
A company has a possible obligation arising from a lawsuit. Lawyers advise that the outcome is uncertain and the chance of losing is about 20%. A loss, if it occurred, could be reliably estimated at $400,000. Under IAS 37, how should the company treat this item in its financial statements?
The company should disclose a contingent liability in the notes. The obligation is only possible, since an outflow is not probable, so no provision is recognised. A 20% chance is not remote, so disclosure cannot be omitted.
- ARecognise a provision of $400,000
- BRecognise a provision of $80,000
- CDisclose a contingent liability in the notesCorrect
- DMake no disclosure because the probability is low
Explanation
A possible obligation, where an outflow is not probable but also not remote, is a contingent liability. It is disclosed in the notes and not recognised. A 20% chance is not remote, so disclosure is needed. Recognising an expected value of $80,000 is wrong because IAS 37 does not use probability weighting for single obligations.
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