7.4 L plc sells gaming cards to retailers, who then resell them to the general public. Customers who buy these cards scratch off a panel to reveal whether they have won a cash prize. There are several different ranges of cards, each of which offers a different range of prizes. Prize-winners send their winning cards to L plc and are paid by cheque. If the prize is major, then the prize-winner is required to telephone L plc to register the claim and then send the winning card to a special address for separate handling. All cards are printed and packaged under conditions of high security. Special printing techniques make it easy for L plc to identify forged claims and it is unusual for customers to make false claims. Large claims are, however, checked using a special chemical process that takes several days to take effect. The directors are currently finalising their financial statements for the year ended 31 March 2002. They are unsure about how to deal with the following items: (i) A packaging error on a batch of ‘Chance’ cards meant that there were too many major prize cards in several boxes. L plc recalled the batch from retailers, but was too late to prevent many of the defective cards being sold. The company is being flooded with claims. L plc’s lawyers have advised that the claims are valid and must be paid. It has proved impossible to determine the likely level of claims that will be made in respect of this error because it will take several weeks to establish the success of the recall and the number of defective cards. (ii) A prize-winner has registered a claim for a £200 000 prize from a ‘Lotto’ card. The financial statements will be finalised before the card can be processed and checked. (iii) A claim has been received for £100 000 from a ‘Winner’ card. The maximum prize offered for this game is £90 000 and so the most likely explanation is that the card has been forged. The police are investigating the claim, but this will not be resolved before the financial statements are finalised. Once the police investigation has concluded, L plc will make a final check to ensure that the card is not the result of a printing error. (iv) The company received claims totalling £300 000 during the year from a batch of bogus ‘Happy’ cards that had been forged by a retailer in Newtown. The police have prosec- uted the retailer and he has recently been sent to prison. The directors of L plc have decided to pay customers who bought these cards 50% of the amount claimed as a goodwill gesture. They have not, however, informed the lucky prize-winners of this yet. Required (a) Identify the appropriate accounting treatment of each of the claims against L plc in respect of (i) to (iv) above. Your answer should have due regard to the requirements of FRS 12, Provisions, contingent liabilities and contingent assets. (b) It has been suggested that readers of financial statements do not always pay sufficient attention to contingent liabilities even though they may have serious implications for the future of the company. (i) Explain why insufficient attention might be paid to contingent liabilities. (ii) Explain how FRS 12 prevents companies from treating as contingent liabilities those liabilities that should be recognised in the balance sheet.
7.4 L plc sells gaming cards to retailers, who then resell them to the general public. Customers who buy these cards scratch off a panel to reveal whether they have won a cash prize. There are several different ranges of cards, each of which offers a different range of prizes.
Prize-winners send their winning cards to L plc and are paid by cheque. If the prize is major, then the prize-winner is required to telephone L plc to register the claim and then send the winning card to a special address for separate handling.
All cards are printed and packaged under conditions of high security. Special printing techniques make it easy for L plc to identify forged claims and it is unusual for customers to make false claims. Large claims are, however, checked using a special chemical process that takes several days to take effect.
The directors are currently finalising their financial statements for the year ended 31 March 2002. They are unsure about how to deal with the following items:
(i) A packaging error on a batch of ‘Chance’ cards meant that there were too many major prize cards in several boxes. L plc recalled the batch from retailers, but was too late to prevent many of the defective cards being sold. The company is being flooded with claims. L plc’s lawyers have advised that the claims are valid and must be paid. It has proved impossible to determine the likely level of claims that will be made in respect of this error because it will take several weeks to establish the success of the recall and the number of defective cards.
(ii) A prize-winner has registered a claim for a £200 000 prize from a ‘Lotto’ card. The financial statements will be finalised before the card can be processed and checked.
(iii) A claim has been received for £100 000 from a ‘Winner’ card. The maximum prize offered for this game is £90 000 and so the most likely explanation is that the card has been forged. The police are investigating the claim, but this will not be resolved before the financial statements are finalised. Once the police investigation has concluded, L plc will make a final check to ensure that the card is not the result of a printing error.
(iv) The company received claims totalling £300 000 during the year from a batch of bogus ‘Happy’ cards that had been forged by a retailer in Newtown. The police have prosec- uted the retailer and he has recently been sent to prison. The directors of L plc have decided to pay customers who bought these cards 50% of the amount claimed as a
Required
(a) Identify the appropriate accounting treatment of each of the claims against L plc in respect of (i) to (iv) above. Your answer should have due regard to the requirements of FRS 12, Provisions,
(b) It has been suggested that readers of financial statements do not always pay sufficient attention to contingent liabilities even though they may have serious implications for the future of the company.
(i) Explain why insufficient attention might be paid to contingent liabilities.
(ii) Explain how FRS 12 prevents companies from treating as contingent liabilities those liabilities that should be recognised in the
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