exam questions Flashcards
- Define Contingent Liability under IAS37?
Points they may cover
Under IAS37, there are 3 conditions that must be met to recognise a contingent liability:
* possible obligation
* existence will be confirmed by uncertain future events
* not wholly within the control of the entity.
An example is litigation against the entity when it is
* uncertain whether the entity has committed an act of wrongdoing
* when it is not probable that settlement will be needed.
Contingent liabilities can adversely impact a company’s assets and net profitability.
- Discuss the conditions that must be met for this company to record a contingent liability and how the size of the liability would be determined?
Application:
For this company, the 3 conditions mentioned above must be met to recognise a contingent liability.
* possible obligation
* existence will be confirmed by uncertain future events
* not wholly within the control of the entity.
The accounting rules for reporting a contingent liability differ depending on the estimated amount of the liability and the likelihood of the event occurring.
Recognition rules if criteria are met depend on likelihood of case going against them.
* Probable: ‘more than likely to go against the company’, and the amount can be reasonably estimated, the liability should be recorded in the accounting records of a firm as a provision at the most likely estimate or outcome.
* Possible: ‘as likely to go against the company as not’, must be disclosed in the notes to the financial statements.
* Remote: ‘unlikely’ to go against the company, can be ignored.
What are the two types of events after the reporting period under IAS 10, and how are they treated?
Under IAS 10, events after the reporting period are classified as:
Adjusting Events:
Provide evidence of conditions that existed at the end of the reporting period.
Action: Adjust the financial statements to reflect these events.
Non-Adjusting Events:
Indicate conditions that arose after the reporting period.
Action: No adjustments to the financial statements, but disclose if material.
Examples:
Adjusting Event: A debtor entering liquidation due to pre-existing financial difficulties.
Non-Adjusting Event: A fire destroying a machine after the year-end.
- Recommend the appropriate treatment for this event, justifying your reasons why.
Application:
The company should discuss the case further with their lawyers and assess the likelihood of an outflow of resources based on the available evidence.
However, if the company’s lawyers believe it is probable that the case will go against them, and they can estimate a potential cost, they should recognise the contingent liability in the accounts with a provision. 2 marks
They would debit legal expense and credit Provision for Law Suit.
If it is only possible the case will go against them, a description of the event should be given to the users, with an estimate of the potential financial effect and timing.
- Discuss the accounting treatment for research costs under IAS38 Intangible Assets and explain to the CFO how they should be accounted for
- Explain what research expenditure refers to , such as those incurred in the discovery of new knowledge or the evaluation of technical feasibility
- Explain the treatment of these costs, ie expensed immediately, and why (ie as they do not meet the criteria for recognition as an asset.)
Application: Comment on how the CEO should review these costs to determine appropriate treatment. (ie. the $15 million in research expenditures incurred during the fiscal year should be written off in the income statement if the research costs cannot be separated from development costs.
- Discuss the accounting treatment for Pharma’s development costs under IAS38 Intangible Assets and how they should be accounted for.
Explain what development expenditure is.
Explain the treatment for development costs Under IAS 38 Development expenditures (ie. can be capitalised as intangible assets if certain strict criteria are met.
Explain the criteria Pharma PLC should assess their research/development costs, including reference to analysying each specific project separately to determine if it qualifies for capitalisation.
PIRATE
- Probable economic benefits: The project should have the potential to generate future economic benefits in the form of profits or cost savings/efficiency gains.
- Intention to complete: The company should have a clear intention to complete the project.
- Resources to Complete: Company X should have the necessary resources, such as funding, personnel, and expertise, to complete the project.
- Ability to use/sell the asset: The company should have plan to either use the resulting asset internally or sell it to external parties.
- Technical feasibility: The project must be technically feasible, meaning the company has the capability to complete it.
- Estimate expenditure reliably: The company should be able to reliably estimate future expenditure.
Application: For Pharma, if these criteria are met for specific R&D projects, the development expenditures for those projects should be capitalised as intangible assets on the balance sheet and subsequently amortised systematically over their useful life.
Discuss the accounting treatment for Pharma PLC’s costs of projects close to completion and expected to generate future economic benefits, specifically referring to the criteria for capitalisation.
Points they may cover (but consider good responses that have other points):
Distinguish between R&D projects that are close to completion and those that are still in progress.
Highlight need to continually review and assess each project and test for impairment/or change in the capitalisation criteria.
Application points:
- Capitalisation: If these projects still meet the criteria, the expenditures incurred on these specific projects should be capitalised as intangible assets, and the associated costs should be amortized systematically over their useful life.
- Disclosures: Additionally, Pharma PLC must ensure compliance with the disclosure requirements of IAS 38, including providing information about the methods and assumptions used in testing for and reversing impairment of these assets.
