Hamilton
Airlines is faced with two situations that need to be resolved before the
financial statements for the company's year ended December 31, 2011, can be
issued.
1.
The airline is being sued for $4 million for an injury caused to a child as a
result of alleged negligence while the child was visiting the airline
maintenance hangar in March 2011. The suit was filed in July 2011. Hamilton's
lawyer states that it is likely that the airline will lose the suit and be
found liable for a judgement costing anywhere from $400,000 to $2 million.
However, the lawyer states that the most probable judgement is $800,000.
2.
On November 24, 2011, 26 passengers on Flight No. 901 were injured upon landing
when the plane skidded off the runway. Personal injury suits for damages totaling $5 million were filed against the airline by 18 injured passengers on
January 11, 2012. The airline carries no insurance. Legal counsel has studied
each suit and advised Hamilton that it can reasonably expect to pay 60% of the
damages claimed.
Instructions
(a)
Prepare any disclosures and journal entries for the airline required by
(1)
Private enterprise GAAP,
(2)
Existing IAS 37 under IFRS in the preparation of the December 31, 2011
financial statements.
(b)
Ignoring the 2011 accidents, what liability due to the risk of loss from lack
of insurance coverage should Hamilton Airlines record or disclose? During the
past decade, the company has experienced at least one accident per year and
incurred average damages of $3.2 million. Discuss fully.
(a) 1.
(i) PE GAAP – Section 3290
It
is likely a loss and liability have been incurred and a reasonable estimate can
be made of the amount. The loss and liability should be recorded as follows:
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Loss from Accident..................................................
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800,000
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Liability
for Accident.........................................
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800,000
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Note to the Financial Statements
The
corporation is a defendant in a personal injury suit for $4,000,000. The
corporation is charging the year of the accident with $800,000 in estimated
losses, which represents the amount the company estimates will likely be
awarded.
(ii) IFRS – IAS 37
IAS
37 would be similar to the PE GAAP standard except IAS 37 uses the recognition
criterion used to determine the chance of occurrence of a confirming future
event is “probable,” which is interpreted to mean “more likely than not.” This
is a somewhat lower hurdle than the “likely” required under private enterprise
standards. If the amount cannot be measured reliably, no liability is
recognized under IFRS either; however, the standard indicates that it is only
in very rare circumstances that this would be the case. If recognized, IAS 37
requires the best estimate and an “expected value” method to be used to measure
the liability. This approach assigned weights to the possible outcomes according
to their associated probabilities when measuring the amount of the provision to
make if a range of possible amounts is available.
2. (i) PE GAAP – Section
3290
Because the cause for litigation occurred before the date
of the financial statements and because an unfavorable outcome is likely and
reasonably estimable, Hamilton Airlines should report a loss and a liability in
the December 31, 2011, financial statements. The loss and liability might be
recorded as follows:
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Loss from Uninsured Accident..........................
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3,000,000
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Liability
for Uninsured Accident.................
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3,000,000
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($5,000,000 X 60%)
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|
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Note to the Financial
Statements
Due
to an accident that occurred during 2011, the corporation is a defendant in
personal injury suits totaling $5,000,000. The corporation is charging the
year of the casualty with management’s best estimate for the total expected
losses, which represents the amount the company estimates will finally be
awarded.
(ii) IFRS – IAS 37
IAS
37 would be similar to the PE GAAP standard with the same exceptions for IAS 37
as noted in part (a)(1)(ii) above.
(b) Hamilton
Airlines need not establish a liability for risk of loss from lack of insurance
coverage itself. CICA Handbook for
Private Enterprises Section 3290 does not require or allow the
establishment of a liability for expected future injury to others or damage to
the property of others even if the amount of the losses is reasonably
estimable. IAS 37 would mirror the PE GAAP standards in this situation. The
cause for a loss must occur on or before the balance sheet date for a loss
contingency to be recorded. However, the fact that Hamilton is self-insured
should be disclosed in a note.
