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

Kaveri Traders Ltd. has a legal dispute in which a customer claims Rs 5,00,000. Lawyers say an outflow is only possible, not probable, and the amount cannot be measured reliably. Under the Framework, the item does not meet the recognition criteria for a liability. What is the appropriate treatment?

The item should not be recognised in the balance sheet but should be disclosed as a contingent liability. Recognition needs a probable outflow and reliable measurement, and neither is satisfied, yet the possible obligation is still relevant information for users of the statements.

  1. ARecognise a liability of Rs 5,00,000 in the balance sheet
  2. BNot recognise it in the balance sheet, but disclose it as a contingent liabilityCorrect
  3. CRecognise Rs 2,50,000 as a liability, being half the claim
  4. DIgnore it completely as no disclosure is required

Explanation

A liability is recognised only when outflow is probable and the amount is reliably measurable. Here neither condition is met, so it is not recognised, but a possible obligation is disclosed as a contingent liability. Recognising half the claim is arbitrary and ignoring it omits relevant information.

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