You are provided with the information below on Speed Boats Marine Pty Ltd (SBM), an entity that makes, distributes and repairs marine engines in Melbourne. The end of the reporting period is June 30.
Extracts from the Statement of Financial Position dated 30 June 2014
Provision for Warranties Non-Current Liabilities
Provision for Warranties $270,000
Plant & Equipment - At Cost
Accumulated Depreciation $1,200,000
Carrying Amount $2,800,000
Plant & Equipment has a useful life of 10 years and is depreciated on a straight line basis. None of the PPE assets were attributed with a residual value by the financial accountant of the company. No impairment losses had been recorded to date.
Note to the Statement: SBM is engaged in litigation with various fishing fleets who believe their engines have not been properly serviced. This includes the allegations that the wrong synthetic motor oil was used by SBM during servicing. SBM denies the allegations as it made all necessary enquiries with the national distributor of the equipment before using the motor oil. As of the day of authorizing the financial statements for issue, SBM is unable to estimate the financial effect, if any, of any costs or damages that may be payable to the plaintiffs.
The Provision for Warranties at 30 June 2014 was calculated using the following assumptions (and there was no balance carried forward from the prior year)
During the year ended 30 June 2015, the following occurred:
1. In relation to the warranty provision at 30 June 2014, $200,000 was paid out of the provision. Of the amount paid, $150,000 was for products with minor defects and $50,000 was for products with major defects, all of which related to amounts that had been expected to be paid in the 2015 financial year.
2. In calculating its warranty provision for 30 June 2015, SBM made the following adjustments to the assumptions used for the prior year.
3. SBM determined that part of its plant & machinery needed an overhaul - a piece of plant would need to be replaced end of May 2016 at an estimated cost of $250,000. The carrying amount of this piece of plant at 30 June 2014 was $140,000. Its original cost was $200,000.
4. SBM was unsuccessful in its defense of the maintenance/motor oil case and was ordered to pay $750,000 to the plaintiffs. As at 30 June 2015 SBM had paid $400,000
5. SBM commenced litigation against one of its advisers for negligent advice given on the original installation of the piece of plant referred to in 3 above. In April 2015 the court found in favor of SBM. The hearing for damages had not been scheduled as at the date the financial statements for 2015 were authorized for issue. SBM estimated it would receive $200,000.
6. SBM signed an agreement with Left Bank to the effect that SBM would guarantee a loan made by Left Bank to SBM’s subsidiary Little SBM Pty Ltd. Little SBMs loan with Left Bank was $1,600,000 as at 30 June 2015 and Little SBM was in a strong financial position at that date.
Answer the questions below regarding SBM remembering the company has to comply with IFR standards and have regard to the IASB Conceptual Framework.
(a) The balance of the warranty provision as at 30 June 2014 is given above. Establish how it was calculated and show your workings.
(b) Find the balance of the warranty provision as at 30 June 2015. Show all your workings.
(c) Calculate the depreciation charge for all PPE assets for the financial year ending 30 June 2015. Show all your workings.
(d) Determine whether the unpaid amount owing as a result of the maintenance/motor oil case is a liability or a provision and give your reasons.
(e) Determine whether the receipt of damages for the negligent advice meets the definition of an asset or a contingent asset and give your reasons.
(f) Determine whether the bank guarantee meets the definition of a provision or a contingent liability and give your reasons.
Remember that the IASB issued an updated version of the Conceptual Framework in March 2018, replacing the 2014 version. This may have a bearing on your thinking in “d” to “f” above.
As you may not find a lot of information on the mechanics of provision in text books, here is some guidance to assist your preparation.
1. When you work out the provision for warranty expenses at 30 June 2014 you need to break up your calculation into 2 parts
(i) The impact your business should see in FY 15 (This is called the current portion of the liability)
(ii) The impact your business should see in FY16 (This is the non-current part). Do not forget to PV this portion for an appropriate number of years (for you to work out how many)
2. There are several ways to get to the provision at the end of 30 June 2015, but whatever calculation you use please remember that in FY15 the business would have charged a certain value of repairs against the provision as successful claims were made. This will have pushed down the provision. You then need to rebuild it to a number that is made up of
a. The impact your business should see in FY 16 (current portion of the liability)
b. The impact your business should see in FY17 (non-current part). Do not forget to PV this portion for an appropriate number of years (for you to work out how many)