A business has been told by its lawyers that it is likely to have to pay $10,000 damages for a product that failed.
The business duly set up a provision at 31
December 20X7. However, the following year, the lawyers found that
damages were more likely to be $50,000. How is
the provision treated in the accounts at:
(a) 31 December 20X7?
(b) 31 December 20X8?
Select one:
O a. 20x7 $40,000 20x8 $10,000
O b. 20x7 $10,000 20x8 $40,000
Oc 20x7 $10,000 20x8 $50,000
Od. 20x7 $50,000 20x8 $10,000

1. At 31 December 20X7, the business initially estimated that it would have to pay $10,000 in damages based on advice from its lawyers. Therefore, the business set up a provision for $10,000 in its financial statements for the year 20X7.

2. By 31 December 20X8, the estimation of the likely damages had increased to $50,000 as per the new findings from the lawyers. This necessitates an adjustment to the provision initially set up.

Now let's consider how these developments impact the accounts:

- For the year ending 31 December 20X7, the provision recorded in the financial statements would have been $10,000, reflecting the best estimate of the obligation at that date.

- For the year ending 31 December 20X8, since the estimate of the obligation has increased to $50,000, the provision needs to be adjusted to reflect the new estimate. The adjustment would be an additional $40,000 to the existing $10,000 provision, making the total provision at 31 December 20X8 $50,000.

Thus, the financial accounting treatment would be as follows:

- (a) At 31 December 20X7: $10,000 (initial provision based on the best estimate at that time).

- (b) At 31 December 20X8: $50,000 (adjusted provision to reflect the updated estimate).

Based on the options provided, the correct answer is:

- (c) 20X7 $10,000 20X8 $50,000.

Explanation: