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CA Intermediate · Advanced Accounting · Framework for Preparation and Presentation of Financial Statements

Kaveri Textiles Ltd. has a policy of recognising an expense in the statement of profit and loss when a decrease in future economic benefits related to a decrease in an asset or an increase in a liability has arisen that can be measured reliably. On 31 March, the company received a legal notice and its lawyers confirmed that it is probable it must pay Rs 4,00,000 as damages, reliably estimated. Under the Framework, how should the company treat this?

The company should recognise a liability and an expense of Rs 4,00,000 in the current year. The obligation is present, an outflow is probable and the amount is reliably measured, so the Framework's recognition criteria are met under the accrual basis, regardless of when cash is paid.

  1. ARecognise a liability and an expense of Rs 4,00,000 in the current yearCorrect
  2. BDisclose only in notes, since payment will occur next year
  3. CRecognise the expense only when the cash is actually paid
  4. DRecognise Rs 2,00,000 as an expense and the rest next year

Explanation

Under the Framework, a liability is recognised when it is probable that an outflow of resources will result from a present obligation and the amount can be measured reliably. Both conditions hold here, so the full Rs 4,00,000 is recognised as liability and expense in the current year. Waiting for cash payment contradicts the accrual basis.

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