A factory owned by CCT Limited was destroyed by fire. CCT Limited lodged an insurance claim for the value of the factory building, plant, and an amount equal to one year’s net profit. During the year there were a number of meetings with the representatives of the insurance company. Finally, before year-end, it was decided that CCT Limited would receive compensation for 90% of its claim. CCT Limited received a letter that the settlement check for that amount had been mailed,but it was not received before year-end. How should CCT Limited treat this in its financial statements?a.Wait until next year when the settlement check is actually received and not recognize or disclose this receivable at all since at year-end it is a contingent asset.b.Because the settlement of the claim was conveyed by a letter from the insurance company that also stated that the settlement check was in the mail for 90% of the claim, record 90% of the claim as a receivable as it is virtually certain that the contingent asset will be received.c.Disclose the contingent asset in the footnotes.d.Because the settlement of the claim was conveyed by a letter from the insurance company that also stated that the settlement check was in the mail for 90% of the claim, record 100% of the claim as a receivable at year-end as it is virtually certain that the contingent asset will be received, and adjust the 10% next year when the settlement check is actually received.
Question
A factory owned by CCT Limited was destroyed by fire. CCT Limited lodged an insurance claim for the value of the factory building, plant, and an amount equal to one year’s net profit. During the year there were a number of meetings with the representatives of the insurance company. Finally, before year-end, it was decided that CCT Limited would receive compensation for 90% of its claim. CCT Limited received a letter that the settlement check for that amount had been mailed,but it was not received before year-end. How should CCT Limited treat this in its financial statements?a.Wait until next year when the settlement check is actually received and not recognize or disclose this receivable at all since at year-end it is a contingent asset.b.Because the settlement of the claim was conveyed by a letter from the insurance company that also stated that the settlement check was in the mail for 90% of the claim, record 90% of the claim as a receivable as it is virtually certain that the contingent asset will be received.c.Disclose the contingent asset in the footnotes.d.Because the settlement of the claim was conveyed by a letter from the insurance company that also stated that the settlement check was in the mail for 90% of the claim, record 100% of the claim as a receivable at year-end as it is virtually certain that the contingent asset will be received, and adjust the 10% next year when the settlement check is actually received.
Solution
The correct treatment in CCT Limited's financial statements would be option b. Because the settlement of the claim was conveyed by a letter from the insurance company that also stated that the settlement check was in the mail for 90% of the claim, CCT Limited should record 90% of the claim as a receivable as it is virtually certain that the contingent asset will be received.
This is in accordance with the accounting principle of prudence, which states that income should not be anticipated unless it is virtually certain. In this case, the insurance company has confirmed the settlement and stated that the check is in the mail, making it virtually certain that the asset will be received.
Option a is not correct because the asset is not contingent, it is virtually certain. Option c is not sufficient because the asset should be recognized in the financial statements, not just disclosed in the footnotes. Option d is not correct because it is not virtually certain that 100% of the claim will be received, only 90% is confirmed.
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