Question

RRR Ltd (RRR) operates in the recycling industry. Three weeks ago, it inadvertently released poisonous gases into the air which caused a number of local residents to become ill.

A law firm representing the 15 affected residents has submitted a compensation claim to the entity for pain and suffering of between $10,000 to $50,000 per affected resident.
The court hearing is scheduled to occur sometime over the next three months. RRR does not believe that it will be required to make any payments to claimants, as this was an accident and no-one has been seriously harmed as a result.
Which of the following is the most correct approach for accounting for this event?
A. Recognise a liability as it is a present obligation arising as a result of a past event that will result in a probable outflow of economic benefits which can be reliably measured.
B. Disclose a contingent liability as it is a possible obligation arising as a result of a past event that may result in a probable outflow of economic benefits which can be reliably measured.
C. No recognition or disclosure is required as there is no present obligation arising as a result of a past event that will result in a probable outflow of economic benefits which can be reliably measured.
D. Disclose a provision as it is a present obligation arising as a result of a past event that will result in a probable outflow of economic benefits which can be reliably measured however the timing of this occurring is uncertain.

Answer 1

The most appropriate approach for RRR Ltd is to disclose a contingent liability, as it faces a potential legal requirement to compensate residents but the outcome and obligation are uncertain.

Step-by-step explanation:

Regarding the situation where RRR Ltd, a company in the recycling industry, inadvertently released poisonous gases that caused residents to become ill and now faces a compensation claim, the correct accounting approach would be to follow financial reporting standards concerning provisions and contingent liabilities. Option B is the most correct approach: Disclose a contingent liability. This is because RRR's situation involves a possible obligation resulting from the past event (the gas release) which may result in an outflow of economic benefits, and the obligation can be reliably measured. The potential payments fall under the concept of contingent liabilities since while an event has occurred, the outcome is not yet certain, and RRR does not recognize this as a present obligation due to its belief that payments will not be made because the harm was not serious.