Question Tag: Provision

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  • 3 Marks

FR – Nov 2019 – L2 – Q2a – Financial Reporting Standards and Their Applications

Treatment of under-provision of tax for Daaho Ltd for the year ending 31 August 2019. Question:

Daaho Ltd (Daaho) manufactures and distributes security equipment. Daaho prepares financial statements in accordance with International Financial Reporting Standards (IFRS) up to 31 August each year.

On 31 August 2019, the taxation liability account in the books of Daaho Ltd showed a debit balance of GH¢17,500 after paying the 2018 liability. The estimated liability for 2019 is GH¢84,500 and no entry has yet been made to record this.

Required:
Explain the appropriate accounting treatment of the above transaction for the year ending 31 August 2019.
(3 marks)

  • A debit balance on the tax account (GH¢17,500) represents under-provision of tax for the previous year (2018). This must be added to the income tax charge for the current year.
  • This means the under-provision should be added to the estimated tax liability for 2019 and treated as the income tax expense for 2019. Thus, a total of GH¢102,000 (GH¢17,500 + GH¢84,500) should be recorded as the income tax expense for 2019.
  • The estimated tax liability of GH¢84,500 should be reported as a current liability in the statement of financial position.

Marks allocation:
Identification of debit balance of GH¢17,500 as under-provision for 2018:
1 mark
Income tax expense GH¢102,000:
1 mark
Current liability of GH¢84,500:
1 mark

  • 5 Marks

CR – Dec 2022 – L3 – Q3a – IAS 36: Impairment of Assets ,IAS 37: Provisions, contingent liabilities and contingent assets

Determine the appropriate accounting treatment for Samed Ltd's production facility impairment.

Samed Ltd is a Ghanaian company located in the Northern Region that manufactures goods such as washing machines, tumble dryers, and dishwashers. The manufacturing industry in Ghana is highly competitive with many products on the market. Samed Ltd’s current accounting year-end is 31 December 2022.

Samed Ltd has a production facility that started showing serious cracks and signs of possible leakage since July 2022. It is probable that Samed Ltd will have to undertake major repairs sometime during 2023 to rectify the problem. Samed Ltd does not have an insurance policy covering the production facility. The Chief Operating Officer has refused to disclose the issue in the financial statements for the year ended 31 December 2022, and no repair costs have yet been undertaken, although he is aware that this is contrary to International Financial Reporting Standards (IFRSs). According to the Chief Operating Officer, he does not believe that the need for major repairs on the production facility is an indicator of impairment. Furthermore, the Chief Operating Officer argues that no provision for the repair to the production facility should be made as there is no legal or constructive obligation to repair the facility.

Samed Ltd has a revaluation policy for property, plant, and equipment, and there is a balance on the revaluation surplus of GH¢20 million in the financial statements for the year ended 31 December 2022. However, this balance does not relate to the production facility, but the Chief Operating Officer is of the opinion that this surplus can be used for any future loss arising from the collapse of the production facility.

Required:
In accordance with relevant IFRSs, discuss the accounting treatment which Samed Ltd should adopt to account for the above transaction in its financial statements for the year ended 31 December 2022.
(5 marks)

In line with IAS 36, the cracks and possible leakage are indicators of impairment for the production facility. The following accounting treatment should be adopted:

  1. Impairment Testing:
    • The production facility should be tested for impairment as it is likely part of a cash-generating unit (CGU). Since the production facility does not independently generate cash flows, it is necessary to combine it with other assets, such as plant and machinery, to form a CGU.
    • The recoverable amount should be determined as the higher of its fair value less costs to sell and value in use.
    • If the carrying amount exceeds the recoverable amount, an impairment loss must be recognized.
  2. Fair Value Consideration:
    • Reference should be made to IFRS 13 for fair value measurement. The fair value could be estimated by considering similar production facilities that have been recently sold, if available.
    • Value in use should be calculated by estimating the future cash flows the facility is expected to generate, discounted at an appropriate rate.
  3. Recognition of Impairment Loss:
    • Any impairment loss should be expensed in the profit or loss statement. The revaluation surplus cannot be used to offset the impairment loss since the revaluation surplus does not specifically relate to the impaired production facility.
  4. No Provision for Repairs:
    • IAS 37 specifies that no provision for repairs should be recognized, as there is no legal or constructive obligation to repair the facility at the reporting date.

(Marks are evenly distributed = 5 marks)

  • 10 Marks

AAA – Nov 2017 – L3 – Q1a – Planning, Audit Evidence

Analyze the materiality of management's plans to discontinue sales of ladies wear and the provision for redundant employees.

The draft accounts of your client Good Days Ltd., a shopping mall for the year ended 31 December 2016 showed the following:

2016 (GH¢ million) 2015 (GH¢ million)
Revenue 84.40 83.60
Profit before tax 5.00 4.40
Total Assets 75.00 46.80

In December 2016, management announced plans to stop the sales of ladies wear from the end of the month. These sales amounted to GH¢1.4 million for the year ended 31 December 2016 (2015 GH¢1.6 million). A provision of GH¢0.6 million has been made at 31 December 2016 for the compensation of redundant employees who are mainly sales girls.

Required:
Comment on the materiality of these two plans.

Note: The following materiality levels are to be used as benchmarks:

Value %
Profit Before Tax 5
Gross Profit ½ – 1
Revenue ½ – 1
Total Assets 1 – 2
Net Assets 2 – 5
Profit After Tax 5 – 12
  • Ladies Wear:
    • Revenue from the ladies wear forms part of the total revenue of the company. The relevant indicator of materiality is therefore revenue.
    • The ladies wear revenue as a percentage of total revenue is as follows:
      • GH¢1.4×100÷84.40=1.66%GH¢ 1.4 \times 100 \div 84.40 = 1.66\%
      • 1.66% is higher than the materiality threshold of ½ -1% of revenue. Therefore, the ladies wear sales revenue is material to the statements of Profit or Loss and other comprehensive income.
    • Marks: 4
  • Provision:
    • The provision should be considered in terms of its effect on the financial statements. It affects both the statement of financial position as it’s a liability in the financial statements and the statement of profit or loss and other comprehensive income as it is a charge in arriving at the profit or loss for the year.
    • Statement of Financial Position:
      • GH¢0.6m×100÷75m=0.8%GH¢0.6m \times 100 \div 75m = 0.8\% of total assets.
      • The materiality threshold for total assets is 1-2% therefore the 0.8% is not material to the statement of financial position.
      • Marks: 3
    • Statement of Profit or Loss and Other Comprehensive Income:
      • GH¢0.6m×100÷5m=12%GH¢0.6m \times 100 \div 5m = 12\%.
      • The materiality threshold for profit before tax is 5% therefore the 12% is material to the statements of profit or loss and other comprehensive income.  Marks: 3

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