Several items are listed for which the outcome of events is unknown at year-end.
ID: 2509342 • Letter: S
Question
Several items are listed for which the outcome of events is unknown at year-end. a. A company offers a two-year warranty on sales of new computers. It believes that 4% of the computers will require repairs. believe that an award of $500,000 in the company's favor will be made. believes that the outcome may be unfavorable but has not been able to estimate the costs of b. The company is involved in a trademark infringement suit. The company's legal experts c. A company is involved in an environmental cleanup lawsuit. The company's legal counsel d. A soap manufacturer has included a coupon offer in the Sunday newspaper supplements. The e. A company has been sued by the federal government for price fixing. The company's legal bethet t aed in an environim entaidavi avor will te the possible loss. manufacturer estimates that 25% of the 50-cent coupons will be redeemed. counsel believes that there will be an unfavorable verdict and has made an estimate of the probable loss. Required 1. Identify which of the items (a) through (e) should be recorded at year-end. 2. Identify which of the items (a) through (e) should not be recorded but should be disclosed in the vear-end financial statements.Explanation / Answer
"A provision shall be recognized when:
Based on above explanation, following items should be recorded at year-end
a. Two years warranty on sale of computer - Reason- Since obligation event (i.e. sale of a product with a warranty) is a past event, a provision should be recognized for the best estimate( in this case 4%) of the cost of making goods under the warranty product sold.
b.Favorable court case - This is a contingent asset. A contingent asset is a possible event that arises from the past events the existences of which will be confirmed by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of a company. A contingent asset should not be recognized in the books since this may result in recognition of income that may never be realized. It is not disclosed in the financial statements. It is usually disclosed in the report of approving authority ( Board of directors in case of company.
c. Unfavorable case law without estimated loss- A company should accrue an estimated loss from a loss contingency by a charge to expense and a liability recorded only if both the following conditions are met-
On the basis of the evidence available, there is a present obligation. However, the amount is not certain. Hence, in this case, a provision should not be recognized in the books but disclosure must be made in the books.
d. Coupon offer- Coupons printed in newspapers are intended to increase the sale of a company. Hence, any cost associated with them should be matched as expenses against revenue in the period of sales. At the end of accounting period, the company should report any outstanding coupon offers that is expected to be redeemed within the next year as a current liability.
e. Unfavorable case law with estimated loss- Based on the explanation given in point "c",
On the basis of the evidence available, there is a present obligation. Hence, in this case, a provision should be recognized in the books.
Following items should not be recorded but disclosed in the books
case "b"- Contingent asset- Contingent asset should not be recorded, but should be disclosed where an inflow of economic benefit is probable.Hence, in this case, it should be disclosed.
Case "c"- It is a contingent liability. An entity should not recognize them, but should disclose them as the possibility of the outflow of the economic resource is remote. If the matter is related to obligation (whether constructive or legal), it leads to provision. It is important to understand whether a provision should be recognized in the books or not.
To recognize a provision, following conditions should be met:
If all three criteria are met, provision should be recognized. If any of them is not met, you should disclose the same in the financials.
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.