FRS 12 – Provisions, Contingent Liabilities and Contingent Assets requires contingencies to be…

FRS 12 – Provisions, Contingent Liabilities and Contingent Assets requires contingencies to be classified as remote, possible, probable and virtually certain. Each of these categories should then be treated differently, depending on whether it is an asset or a liability.

The Chief Accountant of Z plc, a construction company, is finalising the work on the financial statements for the year ended 31 October 2002. She has prepared a list of all of the matters that might require some adjustment or disclosure under the requirements of FRS 12.

(i) A customer has lodged a claim against Z plc for repairs to an office block built by the company. The roof leaks and it appears that this is due to negligence in construction. Z plc is negotiating with the customer and will probably have to pay for repairs that will cost approximately £100000.

(ii) The roof in (i) above was installed by a subcontractor employed by Z plc. Z plc’s lawyers are confident that the company would have a strong claim to recover the whole of any costs from the subcontractor. The Chief Accountant has obtained the subcontractor’s latest financial statements. The subcontractor appears to be almost insolvent with few assets.

(iii) Whenever Z plc finishes a project, it gives customers a period of three months to notify any construction defects. These are repaired immediately. The balance sheet at 31 October 2001 carried a provision of £80 000 for future repairs. The estimated cost of repairs to completed contracts as at 31 October 2002 is £120000.

(iv) During the year ended 31 October 2002, Z plc lodged a claim against a large firm of electrical engineers which had delayed the completion of a contract. The engineering company’s Directors have agreed in principle to pay Z plc £30 000 compensation. Z plc’s Chief Accountant is confident that this amount will be received before the end of December 2002.

(v) An architect has lodged a claim against Z plc for the loss of a laptop computer during a site visit. He alleges that the company did not take sufficient care to secure the site office and that this led to the computer being stolen while he inspected the project. He is claiming for consequential losses of £90 000 for the value of the vital files that were on the computer. Z plc’s lawyers have indicated that the company might have to pay a trivial sum in compensation for the computer hardware. There is almost no likelihood that the courts would award damages for the lost files because the architect should have copied them.

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