Loss Contingency

[GAZLIZ]

I'm looking for some help regarding Loss Contingency. If your contingency is deemed probable, the amount can be reasonable estimated and you accrue the contingency. If the following fiscal year your actual loss is more than what you accrued, how do you record the additional cash outflow - in the case of a law suit - after closing the payable you initially allocated for the contingency entry.

Thank you for any help

[awaisaftab]

Hi,
on the occuring of the event, for which provision has created, the provision and the exceeding outflow of cash both shall be recorded in the relevent account.For instance the provision created for a law suit relating to the worders compensation will be transferer to the "Workers Compesation Account" .
The exceeding outflow shall also be recored as expense or in relevant account beside the amount of provision.If the actual expense or cost is less than the provision created the shortfall shall be added in retained earnings.

Awais Aftab
ACMA (Finalist)

[kamranACA]

Gazliz,

Provisions are basically the accounting estimate which should be made prudently considering all expected effects. However, so many accoutning estimate prove to be critical and there appear some uncertainities attached with their calculations.

If you have made a provision for loss contingency and actual cash outflow in subsequent period exceeded the provision, this is not a thing to worry about or to alter the previously reported figures. For instance if your provision (expense and liability) was Rs. 10 in year 2007 and the actual cash flow was Rs. 15 in year 2008, you simply pass the following accounting entries in year 2008

To record the amount exceeding the last year's provision

.......Expense - further provision DEBIT Rs. 5

............Provision for loss contingency (liability) CREDIT Rs. 5


and;

To pay off the liability

.........Provision for loss contingency DEBIT Rs. 15

........................... Bank account CREDIT Rs. 15


This is very simple you see.


Aftab,


I must place on record that provisions are the accounting estimates and either these are provided or reversed, these don't have to affect retained earnings directly. Instead these have to be charged or reversed in P/L account. No change in accounting estimate directly affects the retained earnings unless it is made as a result of change in some accounting policy. I think you overlooked it.


Regards,


KAMRAN.

[awaisaftab]

Kamran Bhayee

If the provision is reversed in the next year how you can disturbe the P and L A/c. Please reply in detail

[kamranACA]

Dear,

I must ask you to study IAS-8 (specially the paragraphs 32 to 40) to find detailed guideline as to how a change in accounting estimate has to be accounted for.

It's paragraph 36 and 37 are reproduced below for reference

QUOTE

36 The effect of a change in an accounting estimate, other than a change to which paragraph 37 applies, shall be recognized prospectively by including it in profit or loss in

(a) the period of the change, if the change affects that period only; or

(b) the period of the change and future periods, if the change affects both.

37 To the extent that a change in an accounting estimate gives rise to changes in assets and liabilities, or relates to an item of equity, it shall be recognized by adjusting the carrying amount of the related asset, liability or equity item in the period of the change.

UNQUOTE

When a previously recognised provision for loss contingency would be reversed, following accounting entry will be passed

......... Provision for loss contingency (liability account) DEBIT

......... Reversal of provision - Other operating income (P/L account) CREDIT

Therefore, the change in accounting estimate has been accounted for in profit and loss account (instead of directly in the retained earnings) and the corresponding effect has gone to the related liability account to such extent.

I hope this stands clarified.


Regards,


KAMRAN.

[Uzair]

Hey Kamran,, why do you have to create further provision in this case??
Since the loss has already been incurred we can directly expense it out i.e I think we don't need to make the first entry.

[kamranACA]

Dear,

One needs to understand the basics of accounting if he is looking for some explanation.

You can pass following entry

......... Expense (Debit) Rs. 5

..........Provision already made (Debit) Rs. 10

.........................Bank account (Credit) Rs. 15


You can also pass following entries which will give same results

First entry

..............Expense (Debit) Rs. 5
...................Provision (liability) (credit) Rs. 5

Second entry

.............Provision-liability (Debit) Rs. 15
...................Bank (Credit) Rs. 15

So buddy if you will make out the T accounts, you will get same results.

I passed two entries for the sake of clarity.

I don't know why you failed to understand.


Regards,


KAMRAN.

[Uzair]

Yea very true,, I got your point earlier on but mayb I didn't make my point very clear.
I intended to say the same thing wht u did in your first entry of last post.
Newayz thanx for further explanation.
It sure is a learning period for me D