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

Vindhya Chemicals Ltd. has an onerous contract to supply 10,000 units at Rs 90 per unit. Unavoidable cost of fulfilling it is Rs 110 per unit. Alternatively, it can cancel the contract by paying compensation of Rs 1,50,000. Which provision should be recognised?

The provision is Rs 1,50,000. For an onerous contract, the obligation is measured at the lower of the net cost of fulfilling it, which is Rs 2,00,000, and the penalty for exiting it, which is Rs 1,50,000. The cheaper exit route therefore determines the provision.

  1. ARs 1,50,000Correct
  2. BRs 2,00,000
  3. CRs 3,50,000
  4. DRs 0

Explanation

Loss on fulfilling = 10,000 x (110 - 90) = Rs 2,00,000. Cancellation costs Rs 1,50,000. The provision is the lower of the cost of fulfilling and the cost of exiting, i.e. the least net cost, Rs 1,50,000. Rs 2,00,000 ignores the cheaper exit; Rs 3,50,000 wrongly adds both.

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