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CA Intermediate · Advanced Accounting · AS 29 (Revised) Provisions, Contingent Liabilities and Contingent Assets

Mehta Chemicals Ltd. has a contract that has become onerous. Unavoidable cost of meeting its obligations is Rs 18,50,000, while the economic benefits expected under it are Rs 14,00,000. If the company cancels the contract it must pay a penalty of Rs 3,20,000. What amount of provision should be recognised?

The provision is Rs 3,20,000. The unavoidable cost of an onerous contract is the lower of the net cost of fulfilling it, Rs 4,50,000 (18,50,000 less 14,00,000), and the penalty for exit, Rs 3,20,000. The lower figure is provided.

  1. ARs 4,50,000
  2. BRs 3,20,000Correct
  3. CRs 7,70,000
  4. DRs 18,50,000

Explanation

Net cost of fulfilling = 18,50,000 - 14,00,000 = Rs 4,50,000. Cost of exit by penalty = Rs 3,20,000. The unavoidable cost is the lower of the two, so the provision is Rs 3,20,000. Rs 4,50,000 ignores the cheaper exit route.

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