Question

Question 3: (12 Marks)

Cosmetic Ltd. opened its shop in 2018 to sell cosmetic products. The company is well known for its environmental and charity campaigns. The financial statements for the year ended December 31, 2018 were authorised for issue in April 2019.

The following events have occurred recently:

1. To reduce plastic waste, in December 2018, the company announced an environmental campaign that from January 1, 2019 to June 30, 2020, the company would give a $5 refund to a customer for each empty plastic container returned to the company. The company then will recycle the returned containers. The manager estimated that about 50,000 pieces of plastic containers will be returned under this campaign.                                                                                                                        ( 5 marks)

2. In February 2019, Due to the bad allergic reaction while using the company’s skin care products, a customer file a legal claim to sue Cosmetic Ltd. According to the lawyer’s suggestion, Cosmetic is not likely to lose the case.   However, Cosmetic decided to settle the case without fighting in the court by paying $100,000 to the customer in March 2019.  Cosmetic was covered by an insurance policy which will pay the company up to $120,000 for the legal damages.                      ( 7 marks)

Required:

Discuss the appropriate accounting treatment for each item above for the fiscal year ended December 31, 2018. Justify your answer in accordance with the relevant HKASs.  

No accounting entries are required.

Answer 1

1.To reduce plastic waste, in December 2018, the company announced an environmental campaign that from January 1, 2019 to June 30, 2020, the company would give a $5 refund to a customer for each empty plastic container returned to the company. The company then will recycle the returned containers. The manager estimated that about 50,000 pieces of plastic containers will be returned under this campaign. Therefore $250,000 needs to be paid in the period from January 1, 2019 to June 30, 2020 and as the financial statement belongs to December 2018, the estimated amount of $250,000 which will result into outflow from the company needs to be provided for in the books of accounts in the financials for the year ended December 2018. Therefore the company needs to make a provision for $250,000 in its financials.

2. In February 2019, Due to the bad allergic reaction while using the company’s skin care products, a customer file a legal claim to sue Cosmetic Ltd. According to the lawyer’s suggestion, Cosmetic is not likely to lose the case.   However, Cosmetic decided to settle the case without fighting in the court by paying $100,000 to the customer in March 2019.  Cosmetic was covered by an insurance policy which will pay the company up to $120,000 for the legal damages.This situation is a non adjusting event for the financial of year ending December 2018, as the condition of the case was not prevailing in December or before and the case took place in February. Hence no adjustment is required in the financial of December as the transaction pertains to the next accounting period. However the company may provide a foot note in the financials regarding the case by showing its details.