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

Sundaram Textiles Ltd. has a policy of refunding the price of goods to any customer who is dissatisfied within 30 days of purchase. This policy is widely publicised and has been followed consistently for years. At the balance sheet date, based on past experience, the company expects that 2% of goods sold in the last month, which had a sales value of Rs 50,00,000, will be returned. Under AS 29 (Revised), what is the correct treatment?

A provision of Rs 1,00,000 should be recognised. The consistent, publicised refund policy creates a constructive obligation arising from the past sale, an outflow is probable, and the amount is reliably estimated at 2% of Rs 50,00,000, so AS 29 requires a provision rather than mere disclosure.

  1. ARecognise a provision of Rs 1,00,000 because a constructive obligation existsCorrect
  2. BDisclose a contingent liability of Rs 1,00,000 only
  3. CIgnore the matter as no legal obligation exists
  4. DRecognise a provision of Rs 50,00,000 because all sales may be returned

Explanation

The published and consistently followed refund policy creates a valid expectation in customers, so a constructive obligation arises from a past event (the sale). Outflow is probable and is estimated reliably at 2% x Rs 50,00,000 = Rs 1,00,000. Treating it only as a contingent liability is wrong because a present obligation exists.

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