LKAS – 37 Provisions, Contingent Liabilities and Contingent Assets
Questions
01. Which of the following statements about provisions and contingencies is/are correct?
1. A company should disclose details of the change in carrying value of a provision from the
beginning to the end of the year.
2. Contingent assets must be recognized in the financial statements in accordance with the
prudence concept.
3. Contingent liabilities must be treated as actual liabilities and provided for if it is probable that
they will arise.
A. 3 only
B. 2 and 3 only
C. 1 and 3 only
D. All three statements are correct
02. Which of the following statements about contingent assets and contingent liabilities are correct?
1. A contingent asset should be disclosed by note if an inflow of economic benefits is probable.
2. A contingent liability should be disclosed by note if it is probable that a transfer of economic
benefits to settle it will be required, with no provision being made.
3. No disclosure id required for a contingent liability if it is not probable that a transfer of
economic benefits to settle it will be required.
4. No disclosure is required for either a contingent liability or a contingent asset if the likelihood of
a payment or receipt is remote.
A. 1 and 4 only
B. 2 and 3 only
C. 2,3 and 4
D. 1, 2 and 4
03. An ex - Director of X company has commenced an action against the company claiming substantial
damages for wrongful dismissal. The company’s solicitors have advised that the ex – Director is
unlikely to succeed with his claim, although the chance of X paying any moneys to the ex – Director
is not remote. The solicitors’ estimates of the company’s potential liabilities are,
Rs.
Legal Costs (to be incurred whether the claim is successful or not) 50,000
1
Settlement of claim if successful 500,000
550,000
According to LKAS – 37 Provisions, Contingent Liabilities and Contingent Assets, how should this
claim be treated in the financial statements?
A. Provision of Rs. 550,000
B. Disclose a contingent liability of Rs. 550,000
C. Disclose a provision of Rs. 50,000 and a contingent liability of Rs. 500,000
D. Provision of Rs. 500,000 and a contingent liability of Rs. 50,000
04. The following items have to be considered in finalizing the financial statements of Q, a limited
liability company:
1. The company gives warranties on its products. The company’s statistics show that about 5% of
sales give rise to a warranty claim.
2. The company has guaranteed the overdraft of another company. The likelihood of a liability
arising under the guarantee is assessed as possible.
According to LKAS – 37 Provisions, Contingent Liabilities and Contingent Assets, what is the correct
action to be taken in the financial statements for these items?
Create a provision Disclose by note only No action
A. 1 2
B. 1 2
C. 1,2
D. 2 1
05. Which of the following statements about the requirements of LKAS – 37 Provisions, Contingent
Liabilities and Contingent Assets are correct?
1. A contingent asset should be disclosed by note if an outflow of economic benefits is probable.
2. No disclosure of a contingent liability is required if the possibility of a transfer of economic
benefits arising is remote.
3. Contingent assets must not be recognized in financial statements unless an inflow of economic
benefits is virtually certain to arise.
A. All here statements are correct
B. 1 and 2 only
C. 1 and 3 only
D. 2 and 3 only
2
06. Wanda Co. allows customers to return faulty goods within 14 days of purchase. At 30 th November
2021, a provision of Rs. 6,548 was made for sales returns. At 30 th November 2022, the provision was
re-calculated and should now be Rs. 7,634.
What should be reported in Wanda Co.’s Income Statement for the year to 31 st November 2022 in
respect of the provision.
A. A charge of Rs. 7,634
B. A credit of Rs. 7,634
C. A charge of Rs. 1,086
D. A credit of Rs. 1,086
07. Doggard Co. is a business that sells second hand cars. If a car develops a fault within 30 days of the
sale, Doggard Co. will repair it free of charge.
At 30th April 2021, Doggard Co. had made a provision for repairs of Rs. 2,500. At 30 th April 2022,
Doggard Co. calculated that the provision should be Rs. 2,000.
What entry should be made for the provision in Doggard Co.’s Income Statement for the year to 30 th
April 2022?
A. A charge of Rs. 500
B. A credit of Rs. 500
C. A charge of Rs. 2,000
D. A credit of Rs. 2,000
08. Which of the following best describes a provision according to LKAS – 37, Provisions, Contingent
Liabilities and Contingent Assets?
A. A provision is a liability of uncertain timing or amount.
B. A provision is a possible obligation of uncertain timing or amount.
C. A provision is a credit balance set up to offset a contingent asset so that the effect on the
statement of financial position is nil.
D. A provision is a possible asset that arises from past events.
3
09. Which of the following items does the statement below describe?
“A possible obligation that arises from past events and whose existence will be confirmed only by the
occurrence or non-occurrence of one or more uncertain future events not wholly within the entity’s
control”
A. A provision
B. A current liability
C. A contingent liability
D. A contingent asset
10. Montague’s paint shop has suffered some bad publicity as a result of a customer claiming to be
suffering from skin rashes as a result of using a new brand of paint sold by Montague’s shop. The
customer launched a court action against Montague in November 2022, claiming damages of Rs.
50,000. Montague’s lawyer has advised him that the most probable outcome is that he will have to
pay the customer Rs. 30,000.
What amount should Montague include as provision in his account for the year ended 31 st
December 2022?
A. Rs. Nil
B. Rs. 50,000
C. Rs. 30,000
D. Rs. 80,000
(02 X 10 = 20 Marks)
11. Justina supplies fish to a local restaurant. In August 2021, she supplied the restaurant with some
shell-fish, and now she has heard that some of the restaurant’s customers have suffered attacks of
food poisoning. The restaurant has claimed that this is because of Justina’s shell-fish, and has
commenced a legal action against her.
Algridas, a local solicitor who specializes in food-poisoning cases, has advised Justina that she has a
42% chance of loosing the case, and that if she does lose, she will probably have to pay Rs. 300,000
to settle the liability.
4
What is the nature of Justina’s liability, if any, and how should it be treated in her financial
statements for the year ended 31st August 2021?
……………………………………………………………………………………………………………………………………………………………
……………………………………………………………………………………………………………………………………………………………
……………………………………………………………………………………………………………………………………………………………
(04 Marks)
12. Provide journal entries for the following.
A. A manufacturing company offers a trade warranty for all its customers and through that
warranty they facilitate the necessary maintenance or replacements during the first 3 years of
purchase. The expected warranty expense is 5% from its annual sales. Sales for the year is Rs.
5,000,000.
……………………………………………………………………………………………………………………………………………………
……………………………………………………………………………………………………………………………………………………
……………………………………………………………………………………………………………………………………………………..
B. As a business practice, an organization offers to return the cash for the unsatisfied customers.
Although it doesn’t count as a legal obligation, this business practice is infamous with their
customers. The annual cash returns arise due to this business practice is 3% from its sales for
the year. The business has recorded sales of Rs. 1,000,000 for the current year.
……………………………………………………………………………………………………………………………………………………
……………………………………………………………………………………………………………………………………………………
……………………………………………………………………………………………………………………………………………………..
(02 X 04 = 08 Marks)
13. A company sells products with a one-year warranty period and has paid Rs. 470,000 of warranty
expenses for last year sales during the current year. The company is required to provide Rs. 800,000
as warranty expenses from its current year profit for the sales made for the year ended 31 st March
2021. Estimated provision for warranty expenses as at 01 st of April 2020 was Rs. 650,000.
Required,
A. Show the provision for warranty expenses A/C
5
Provision for Warranty Expenses A/C
B. Financial Statement Extracts for the year ended 31 st March 2021
(08 Marks)
14. Explain the accounting treatment to be considered when preparing the financial statements in each
of the following events.
(i) An organization sells products with warranty. They reliably estimate that to fulfill the
obligation it would cost them 5% from annual sales value.
………………………………………………………………………………………………………………………………………………
………………………………………………………………………………………………………………………………………………
……………………………………………………………………………………………………………………………………………….
6
(ii) As per the Payment of Gratuity Act, company needs to pay gratuity when an employee
resigns from the company. It is estimated that 50% from monthly salary will be spent to pay
gratuity for employees. Annual salary is Rs. 240,000.
………………………………………………………………………………………………………………………………………………
………………………………………………………………………………………………………………………………………………
……………………………………………………………………………………………………………………………………………….
(iii) An ex - employee who got fired, filed a case against the company asking for compensation
for wrongful dismissal. As per lawyers’ judgement, the ex – employee has filed strong
evidence to the court which will require the settlement of compensation.
………………………………………………………………………………………………………………………………………………
………………………………………………………………………………………………………………………………………………
……………………………………………………………………………………………………………………………………………….
(iv) An Environmental Movement filed a court case against the business requesting a
compensation of Rs. 500,000. There is no much evidence to decide the verdict of the court.
………………………………………………………………………………………………………………………………………………
………………………………………………………………………………………………………………………………………………
……………………………………………………………………………………………………………………………………………….
(v) The company expects to receive damages of Rs. 150,000 from another company who
breached a legal contract. But the verdict is still not probable.
………………………………………………………………………………………………………………………………………………
………………………………………………………………………………………………………………………………………………
……………………………………………………………………………………………………………………………………………….
(02 X 05 = 10 Marks)
