On 31 December 20X5, Gamma Co. became aware that a new environmental protection law, enacted on 1 January 20X6, would require significant modifications to its existing factory machinery. Non-compliance after 30 June 20X6 would result in substantial fines. Gamma Co. estimates the cost of these modifications to be $500,000, and it is considered probable that the modifications will be undertaken. Which of the following statements is correct regarding the accounting treatment of this situation in Gamma Co.'s financial statements for the year ended 31 December 20X5?

Question

Accepted Answer

No provision should be recognised because there is no present obligation as a result of a past event at 31 December 20X5.

Answer

A provision of $500,000 should be recognised, and a contingent asset disclosed for any expected recovery from the government, as the environmental law is new.

Answer

No provision or contingent liability should be recognised or disclosed, as the law was enacted after the reporting date and the modifications are not yet probable at 31 December 20X5.

Answer

A provision of $500,000 should be recognised as it is a probable outflow of economic benefits arising from a present obligation.

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