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ACCA Applied Knowledge · Financial Accounting · Qualitative characteristics of useful financial information

At the year end a company is sued, and its lawyers advise that it is probable the company will lose and pay damages, best estimated at $80,000. A director argues that no liability should be recorded until the court rules. Which treatment is consistent with prudence and faithful representation?

The company should recognise a provision of $80,000. The outflow is probable and reliably estimable, so a liability is recorded at the best estimate. Merely disclosing it would understate liabilities, and doubling the amount would breach neutrality by deliberate overstatement.

  1. AIgnore it until the court rules, as a gain cannot be recognised
  2. BRecognise a provision of $80,000 as the obligation is probable and can be estimated reliablyCorrect
  3. CDisclose a contingent liability only, without recognising it
  4. DRecognise a provision of $160,000 to be extra cautious

Explanation

Where an outflow is probable and a reliable estimate exists, a provision is recognised at the best estimate, here $80,000. Disclosure only applies where an outflow is merely possible. Doubling the amount would be deliberate overstatement, which breaches neutrality.

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