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Provisions, contingent liabilities and contingent assets

Example 8.1

Axe Capital is being sued as a result of an accident on the business’s premises.
The claimant is suing for $1m and Axe Capital’s solicitor advises that there is a
30% chance of not having to incur the compensation.

In addition, Axe Capital claimed compensation of $300,000 from a supplier for
breach of copyright. The solicitors of Axe Capital have advised that their claim is
80% likely to succeed.

Which one of the following is the correct treatment of the above situation
in the financial statements of Axe Capital?

A A liability of $1m and an asset of $300,000 should be recognised in the
financial statements.

B No liability will be recorded or disclosed and an asset of $240,000 should
be recognised in the financial statements.

C A liability of $1m will be recorded and a contingent asset should be
disclosed in a note to the financial statements.

D A disclosure is required for both the potential liability and the potential
asset.

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