Maxwell Ltd is a manufacturing company that operates a production facility in the Sydney suburb of Forest Hills. In January 2017, residents living adjacent to the production facility complained that groundwater was being contaminated from waste discharged from Maxwell Ltd’s production facility. In May 2017, environmental officers from the City of Sydney Council confirmed the existence of groundwater contamination although they did not regard the contamination as particularly serious. Maxwell Ltd immediately responded by implementing new procedures for the storage and disposal of waste material to prevent any further contamination from occurring. Although Maxwell Ltd is not required by law to restore the contaminated environment, the company made a series of public announcements that it would undertake to restore the contaminated environment in two years’ time.

As at 30 June 2017, Maxwell Ltd estimates the cost of restoring the contaminated environment as follows:

             Cost                                                                      Probability             

   $420,000                                                                                    20%             

     400,000                                                                                    70%

     300,000                                                                                      5%

     200,000                                                                                      5%             

Also on this date the risk-free discount rate, based on two-year government bonds, is 6%. However, Maxwell Ltd believes that a discount rate of 4% is appropriate to adjust for the risks specific to this liability.

Required

1. How is a provision defined in AASB 137 Provisions, Contingent Liabilities, and Contingent Assets? Why would Maxwell Ltd’s obligation to restore the contaminated environment be classified as a provision?             

2. Briefly explain the three methods that, according to AASB 137 Provisions, Contingent Liabilities and Contingent Assets, can be used by an entity to estimate the amount to be recognized as a provision.                    
3. How has Maxwell Ltd taken risk into account to estimate the amount to be recognized as a provision? What is an alternative approach to taking risk into account?                                                                              

Determine the amount that, in your judgment, Maxwell Ltd should recognize as a provision as of 30 June 2017. Justify the approach that you used to calculate the amount

Answer rating: 100% (QA)

1 According to AASB 137 provision contingent liability and contingent asset are defined as follows i A provision is a liability of uncertain timing or ... View the full answer