Question $6$

a$)$ List and explain the recognition criteria for provisions.

$(5$ marks$)$

b$)$ On a transatlantic flight operated by WIS plc in January $2019,$ several passengers scalded

themselves with hot coffee. The passengers subsequently filed a class action. The lawsuit results

in a compensation claim of $500,000$ with a probability of $40\%.$ Explain whether WIS plc has to

recognise a provision in its financial statements for the year ending $31$ December $2019.$ If it

does, determine the value at initial recognition and prepare the corresponding journal entry.

$(2$ marks$)$

c$)$ In the year ending $31$ December $2019,$ TLV plc sells $50,000$ smartphones with $12-$month product

warranties. In previous years, product warranties resulted in claims for $15\%$ of smartphones sold

to customers, with one third of claims relating to minor defects and two thirds to major defects.

Currently, average costs to repair a minor defect are $20$; average costs to repair a major defect

are $250.$ At the end of the fiscal year, no customer has made a claim under the product

warranty yet. Explain whether TLV plc has to recognise a provision in its financial statements for

the year $2019.$ If it does, determine the value at initial recognition and prepare the

corresponding journal entry.

$(7$ marks$)$

$8$ Please turn over

d$)$ ISR plc is involved in a patent dispute with GUW plc$.$ GUW plc accuses ISR plc to have used and

sold products for which GUW plc holds patents. The alleged patent infringement took place over

several years. A final court decision is expected for $2020.$ In $2019,$ the legal department of ISR plc

expects a conviction with a probability of $90\%.$ In case of conviction, the legal department

further expects that ISR plc has to pay compensation in the amount of $($i$)5,000,000$ with a

probability of $15\%$; $($ii$)15,000,000$ with a probability of $60\%$; or $($iii$)20,000,000$ with a

probability of $25\%.$ ISR plc has not recognised a provision in earlier years. Explain whether ISR

plc has to recognise a provision in its financial statements for the year ending $31$ December

$2019.$ If it does, determine the value at initial recognition and prepare the corresponding journal

entry.

$(7$ marks$)$

e$)$ Earnings management is in part the result of flexibility offered by accounting standards. With

regard to the recognition and measurement of provisions, where do you see such flexibility?

Provide at least two examples and explain how they grant flexibility.