ChemX Inc, a chemical company, found out one week before its fiscal year end 12/31/X1 that its branch leaked significant amount of mercury (above safety level) at a plant site in Country A that requires a chemical company to buy and install specialized equipment (costing $500,000) to prevent mercury leakage. Country A also has legislation that requires a company to clean up mercury contamination.
As of 12/31/X1, ChemX has not bought and installed the specialized equipment, and there has been no allegation against ChemX regarding the mercury leakage. ChemX estimated that there is about 70% probability that it will be subject to an enforcement action by Country A’s environmental authority. ChemX incurred $1 million to clean up a similar mercury contamination at its plant site in another nearby country last year.
Required:
Use IFRS to answer each question below.
A. As of 12/31/X1, is ChemX required to recognize a liability relating to the purchase and installation costs of the specialized equipment? Why?
Tip: By law, a motorist should not drive a car with a broken windshield. If your car has a broken windshield and you have not yet replaced it, when will you incur an obligation to pay for material and labor costs of windshield replacement?
B. As of 12/31/X1, is ChemX required to recognize a liability relating to cleaning up the contaminated site in Country A? Why?
C. If Country A has NO legislation that requires a company to clean up mercury contamination, as of 12/31/X1 is ChemX required to recognize a liability relating to the clean up? Why?
D. If Country A has NO legislation that requires a company to clean up mercury contamination; and if ChemX has widely published a policy to clean up all contamination sites that it causes, and has been honoring this policy, as of 12/31/X1 should ChemX recognize a liability relating to the clean up? Why?
Tips:
Does ChemX have a present obligation?
Can a reliable estimate of the obligation be made?
Is an outflow of resources “probable” to settle the obligation?
Note that IFRS and U.S. GAAP have a different definition of “probable”.