Sound Audio manufactures and sells audio equipment for automobiles. Engineers no

Question

Sound Audio manufactures and sells audio equipment for automobiles. Engineers notified management in December 2016 of a circuit flaw in an amplifier that poses a potential fire hazard. An intense investigation indicated that a product recall is virtually certain, estimated to cost the company $10.5 million. The fiscal year ends on December 31.

What liability, if any, should Sound Audio report in its 2016 balance sheet? (Enter your answers in millions rounded to 1 decimal place (i.e., 5,500,000 should be entered as 5.5).)

Prepare any journal entry needed. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field. Enter your answers in millions rounded to 1 decimal place (i.e., 5,500,000 should be entered as 5.5).)

PLEASE CHOOSE FORM THE LIST BELOW TO JOURNALIZE

Note: DEBITS BEFORE CREDITS

No journal entry required

Accounts receivable

Allowance for uncollectible accounts

Bad debt expense

Bonds payable

Cash

Cost of goods sold

Deferred rent revenue

Deferred sales revenue

Discount on notes payable

Estimated warranty liability

Interest expense

Interest payable

Interest receivable

Interest revenue

Liability—product recall

Loss—product recall

Notes payable

Notes receivable

Rent revenue

Salaries and wages expense

Salaries and wages payable

Sales revenue

Warranty expense

a. Record the liability on product recall.

Explanation / Answer

1. As per the accounting principles, an entitiy should provide for all the expected losses or expenses but do not provide for the expected gains. Moreover, as per Financial Reporting Standards, all the future events that may affect the amount required to settle the entity’s obligation should be reflected in the amount of a provision where there is sufficient objective evidence that they will occur. In the given question, it is clearly specifie investigation indicated that a product recall is virtually certain because of flaw in amplifiers and is estimated to cost the company $10.5 million. Since the event is virtually certain and bound to happen in future, Sound Audio is required to create a provision for the same in the books of accounts. Therefore, this loss contingency should be accrued in Financial Statements.

2. Due to product recall, Sound Audio is estimating a cost of $10.5 million to the company. Therefore, loss of $10.5 millions should be recorded in the books of account.

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