During the year, QA Ltd. delivered manufactured products to customer K. The products were faulty and on 1st October, 2023 customer K commenced legal…

CA Intermediate · Advanced Accounting · RTP · January 2025
During the year, QA Ltd. delivered manufactured products to customer K. The products were faulty and on 1st October, 2023 customer K commenced legal action against the Company claiming damages in respect of losses due to the supply of faulty product. Upon investigating the matter, QA Ltd. discovered that the products were faulty due to defective raw material procured from supplier F. Therefore, on 1st December, 2023, the Company commenced legal action against F claiming damages in respect of the supply of defective raw materials. QA Ltd. has estimated that it's probability of success of both legal actions, the action of K against QA Ltd. and action of QA Ltd. against F, is very high. On 1st October, 2023, QA Ltd. has estimated that the damages it would have to pay K would be 5 crore. This estimate was revised to 5.2 crore as on 31st March, 2024 and - 5.25 crore as at 15th May, 2024. This case was eventually settled on 1st June, 2022, when the Company paid damages of 5.3 crore to K. On 1st December, 2023, QA Ltd. had estimated that it would receive damages of 3.5 crore from F. This estimate was revised to 3.6 crore as at 31st March, 2024 and - 3.7 crore as on 15th May, 2024. This case was eventually settled on 1st June, 2022 when F paid - 3.75 crore to QA Ltd. QA Ltd. had, in its financial statements for the year ended 31st March, 2024, provided - 3.6 crore as the financial statements were approved by the Board of Directors on 26th April, 2024. Whether the Company is required to make provision for the claim from customer K as per applicable AS? If yes, please give the rationale for the same.If the answer to (a) above is yes, what is the entry to be passed in the books of account as on 31st March, 2024?What will the accounting treatment of the action of QA Ltd. against supplier F as per applicable AS?

Suggested Answer and Working Notes:

(i) Yes, QA Ltd. is required to make provision for the claim from customer K as per AS 29 since the claim is a present obligation as a result of delivery of faulty goods manufactured. Also, it is probable that an outflow of resources embodying economic benefits will be required to settle the obligations. Further, a reliable estimate of 5.2 crore can be made of the amount of the obligation while preparing the financial statements as on 31st March, 2024. (ii) Statement of Profit and Loss A/c Dr.5.2 crore To Current Liability A/c - 5.2 crore (iii) As per para 30 of AS 29, QA Ltd. shall not recognise a contingent asset. Here the probability of success of legal action is very high but there is no concrete evidence which makes the inflow virtually certain. Hence, it will be considered as contingent asset only and shall not be recognized.

Topics: AS 29

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