Page 22 - CIMA MCS Workbook November 2018 - Day 2 Suggested Solutions

CIMA NOVEMBER 2018 – MANAGEMENT CASE STUDY

TASK 3 – POSSIBLE CLAIM FOR COMPENSATION

From: Finance Manager
To: Yulia Pushkin
Subject: Possible claim for compensation

Provisions
IAS 37 Provisions, Contingent Liabilities and Contingent Assets (IAS 37) specify three criteria for
recognition of a provision in financial statements as follows:

● there must be a present obligation (legal or constructive) arising from a past transaction or
event.
● It is probable that there will be a future transfer or outflow of economic benefits, and
● It can be measured reliably.
If all three criteria have not been complied with, no provision can be recognised in the financial
statements.

A legal obligation may arise from operation of law or the terms of a contract. Grapple has a legal
obligation to comply with all legislation that applies to the operation of its drinks manufacturing
activities. This could be, for example, ensuring that all production employees have the
appropriate health and safety training and supervision to perform their work safely and ensuring
that all plant and equipment meet legal requirements for safety and mechanical standards.
Breach of a legal obligation may be established, for example, if a machine was determined not to
be safe to use.

A constructive obligation arises when a third party has a valid expectation that it will be able to
rely upon the statements and behaviour of another party, such that an obligation is created and
should be recognised in the financial statements. If Grapple has made public statements regarding
its safety standards or commitment to environmental protection, they may form the basis of a
constructive obligation. For example, if Grapple has published statements in its annual report or
in the press claiming that ‘Grapple goes the extra mile’ to ensure the safety of its employees or to
minimise environmental damage as a result of its production activities, this may be considered to
be breach of a constructive obligation.

It must also be established that there will be a probable outflow of economic benefits. An event is
regarded as probable if it is more likely than not to occur. If a legal or constructive obligation is
established, the probable outflow of economic benefits will derive from the consequences of
breach of the obligation. For example, if the machine involved in the accident was deemed not to
be safe following investigation this may result in liability to pay compensation to the injured
employee. It may also result in criminal penalties if it is established that health and safety law was
breached.

In terms of reliable measurement, insurance companies, loss assessors or lawyers should be able
to quantify the financial consequences of breach of obligations arising from the accident. For
example, solicitors who specialise in accident and injury claims will have expertise in quantifying
such claims.

112 KAPLAN PUBLISHING