On 31 December 20X8 (fiscal year end), Bruinzee NV is in the process of defending a legal case brought against it for damages caused by the use of some of its products. Bruinzee's legal advisors provided the following estimates of the likely outcome of the litigation:
n 60 per cent probability of defending the case successfully;
n 30 per cent probability of being required to pay €4m in damages;
n 10 per cent probability of being required to pay €6m in damages.
Given these estimates, a provision of €1.8m (60 per cent × nil 1 30 per cent × €4m 1 10 per cent × €6m) has been recognized in the 20X8 financial statements. Moreover, the Board of Directors of Bruinzee NV estimate that total legal costs of defending the case will amount to €300 000 (of which
€200 000 has already been invoiced by the legal advisors covering fees up to and including 31 December 20X8). The legal fees of €200 000 have been expensed but the remaining expected future legal costs have not yet been provided for at the end of 20X8.
In the event of successfully defending the litigation case, the legal costs will be recovered, but this has not yet been reflected in the 20X8 financial statements of Bruinzee NV.
Required
(a) Evaluate the accounting treatment applied by Bruinzee NV. If you do not agree, propose and explain appropriate adjustments.
(b) Idem, considering the following revised estimates of Bruinzee's legal advisors and provision amount: '30 per cent probability of defending the case successfully - 60 per cent probability of beingrequired to pay €4 million in damages - 10 per cent probability of being required to pay €6 million in damages. Given these estimates, a provision of €3m (30 per cent 3 nil 1 60 per cent 3 €4m 1 10 per cent 3 €6m) has been recognized in the 20X8 financial statements.'