In determining if a contingent liability should be recognized or not on the balance sheet at the report date, management must decide if there is a present obligation or a contingent obligation or both. Only a present obligation would be recorded under IFRS.
Instructions
For each of the following cases, determine if there is a present obligation and/or a contingent obligation, giving support for your answer assuming the company follows IFRS.
(a) Food for Thought is a restaurant that held a Christmas party in early December for a customer. During the party, 30 people became violently ill, possibly from food poisoning, and had to be hospitalized. Two months later, there are still lingering effects from this illness. The restaurant is now being sued for damages. However, Food for Thought disputes the charges and does not believe that the food it served is to blame. The year-end report is just being finalized for December 31. The entity's lawyers believe that it is unlikely that the restaurant will be found liable.
(b) Encor Oil is an oil company, operating in Country A and Country B, that has caused contamination at all of its oil production sites. Encor only cleans up when it is required to do so by the country's laws. In Country A, the laws have just been amended, on December 31, 2014, to require companies to clean up any environmental contamination that they have caused in the past and, of course, any new contamination done going forward. In Country B, although new legislation is being considered with respect to environmental cleanup, nothing yet has been legislated.
(c) A manufacturer provides a three-year warranty to repair or replace any defective products that have been sold. It also, in the past, has replaced parts for some key customers where the defect was found four years after the date of sale. The company decided to replace these goods in order to maintain good relations with these customers.