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197) In 2018, Cap City Inc. introduced a new line of televisions that carry a two-year warranty
against manufacturer’s defects. Based on past experience with similar products, warranty costs
are expected to be approximately 1% of sales during the first year of the warranty and
approximately an additional 3% of sales during the second year of the warranty. Sales were
$6,000,000 for the first year of the product’s life and actual warranty expenditures were $29,000.
Assume that all sales are on credit.
Required:
1. Prepare journal entries to summarize the sales and any aspects of the warranty for 2018.
2. What amount should Cap City report as a liability at December 31, 2018?
198) Albertson Corporation began a special promotion in July 2018 in an attempt to increase
sales. A coupon was provided at various grocery stores upon checkout. Customers could send in
five coupons to receive $3.00. Albertson’s management estimated that 80% of the coupons would
be redeemed. For the six months ended December 31, 2018, the following information is
available:
Coupons distributed
2,000,000
Coupons redeemed
560,000
Required:
What is the estimated liability associated with the coupons at December 31, 2018?
Number of coupons issued
Expected participation rate
Expected coupon redemptions
Divided by # of coupons per $3 payment
Estimated payments to be awarded
Number awarded to date (560,000 ÷ 5)
Expected future payments
Amount of each payment
Estimated liability, Dec. 31, 2018
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199) Fusion, Inc. introduced a new line of circuits in 2018 that carry a four-year warranty against
manufacturer’s defects. Based on experience with previous product introductions, warranty costs
are expected to approximate 3% of sales. Sales and actual warranty expenditures for the first year
of selling the product were:
Actual warranty
Sales Expenditures
$15 million $200,000
Required:
1. Does this situation represent a loss contingency? Why or why not? How should it be
accounted for?
2. Prepare journal entries that summarize sales of the circuits (assume all credit sales) and any
aspects of the warranty that should be recorded during 2018.
3. What amount should Fusion report as a liability at December 31, 2018?
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200) Barone, Inc. is involved with several situations that possibly involve contingencies. Each is
described below. Barone’s fiscal year ends December 31, and the 2018 financial statements are
issued on March 1, 2019.
1. At March 1, 2019, the EPA is in the process of investigating possible chemical leaks at two
of Barone’s facilities, but has not proposed a deficiency assessment. Management feels an
assessment is reasonably possible, and if an assessment is made an unfavorable settlement of up
to $8 million is reasonably possible.
2. Barone is the plaintiff in a $33 million lawsuit filed against Faze Corp. for damages due to
lost profits from rejected contracts and for unpaid receivables. The case is in final appeal and
legal counsel advises that it is probable that Finley will prevail and be awarded $25 million.
3. In July 2017, the State of Arkansas filed suit against Barone, seeking civil penalties and
injunctive relief for violations of environmental laws regulating hazardous waste. On February
12, 2019, Barone reached a settlement with state authorities. Based upon discussions with legal
counsel, the Company feels it is probable that $13 million will be required to cover the cost of
violations. Barone believes that the ultimate settlement of this claim will not have a material
adverse effect on the company.
4. Barone is involved in a lawsuit resulting from a dispute with a customer. On January 5, 2019,
judgment was rendered against Barone in the amount of $16 million plus interest, a total of $18
million. Barone plans to appeal the judgment and is unable to predict its outcome though it is not
expected to have a material adverse effect on the company.
Required:
1. Determine the appropriate means of reporting each situation. Explain your reasoning.
2. Prepare any necessary journal entries and disclosure notes.
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201) At the beginning of 2018, Scarlet Industries began providing a three-year warranty on its
products. The warranty program was expected to cost Scarlet 2% of net sales, approximately
equally over the three-year warranty period. Net sales made under warranty in 2018 were $270
million. Thirteen percent of the units sold were returned in 2018 and repaired or replaced at a
cost of $2 million. This amount was debited to warranty expense as incurred.
Required:
Prepare the appropriate adjusting entry to adjust warranty expense on December 31, 2018. Show
calculations.
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202) Yummy Rice Cereal offers an all-star bowl in exchange for three proof-of-purchase box
tops. Yummy Rice estimates that 30% of box tops will be redeemed. The bowls cost Yummy
Rice $1 each. In 2018, 5,000,000 boxes of cereal were sold. By year-end 900,000 box tops had
been redeemed.
Required:
Calculate the liability that Yummy Rice should report at December 31, 2018.
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203) Sunnyvale Computer Company sells a line of computers that carry a six-month warranty.
Customers are offered the opportunity to buy a two-year extended warranty for an additional
charge. During 2018, Sunnyvale received $320,000 from customers for these extended
warranties. All sales are on credit, and funds are received evenly throughout the year and the
warranties go into effect immediately after purchase.
Required:
Prepare a summary journal entry to record sales of the extended warranties. Also prepare any
other entries associated with the warranties that should be recorded during 2018.
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204) Hardin Widget Manufacturing began operations in January 2018. Hardin sells widgets that
carry a two-year manufacturer’s warranty against defects in workmanship. Hardin’s management
projects that 2% of the widgets will require repair during the first year of the warranty while
approximately 6% will require repair during the second year of the warranty. The widgets sell for
$400 each. The average cost to repair a widget is $50. The company sells 60% of the widgets to
retail customers who must pay a 6% sales tax. Sales and warranty information for 2018 and 2019
are as follows:
2018: Sold 200 widgets on account; incurred warranty expenditures of $300.
2019: Sold 300 widgets on account; actual warranty expenditures were $500.
Required:
1. Prepare journal entries that summarize the sales and any aspects of the warranty for 2018.
2. Prepare journal entries that summarize the sales and any aspects of the warranty for 2019.
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205) Cracker Corporation began a special promotion in July 2018 in an attempt to increase sales.
A coupon was included in various print advertisements. Customers could send in five coupons to
receive $2.00. Cracker’s management estimated that 70% of the coupons would be redeemed.
For the six months ended December 31, 2018, the following information is available:
Coupons distributed
2,000,000
Coupons redeemed
560,000
Required:
Record all necessary journal entries for the coupon offer for 2018.
Estimated liability
[$2 x (2,000,000 x 70%) ÷ 5]
Estimated premium liability
Cash
(560,000 ÷ 5) x $2
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206) Muller Corp. pays its employees monthly. The payroll information listed below is for
January 2018, the first month of Muller’s fiscal year.
Salaries $400,000
Federal income taxes to be withheld 80,000
Federal unemployment tax rate 0.80%
State unemployment tax rate (after FUTA deduction) 5.40%
Social Security tax rate 6.2%
Medicare tax rate 1.45%
Required:
Prepare the appropriate journal entries to record salaries and wages expense and payroll tax
expense for the January 2018 pay period.
208) Define the following:
1. Liabilities that are definite in amount.
2. Liabilities that must be estimated.
3. Liabilities that are contingent.
209) Bank loans are often arranged in advance as lines of credit. What is a line of credit? How do
a committed and a noncommitted line of credit differ?
112
210) How are customer advances and refundable deposits similar and yet different?
211) Define and distinguish between current and noncurrent liabilities.
113
212) a) What non-accounting factors are important before evaluating whether a pending lawsuit
should be accrued as a liability and reflected in the financial statements?
b) What accounting factors should be considered in determining whether a pending lawsuit
should be accrued as a liability and reflected in the financial statements?
213) Identify and define the three classifications prescribed by GAAP regarding accounting for
contingencies to identify the range of possibilities for the likelihood of a confirming event for
contingent liabilities. Describe the accounting action to be taken for each term.
214) Define a loss contingency and give two examples that almost always are accrued.
215) Texon Oil is being sued for price fixing and environmental damage. The litigation started
this year and is expected to last five years. There is no doubt that Texon is guilty, but the
settlement cost will be between $3 billion and $22 billion. Briefly explain how Texon would
address this in its current year financial statements.
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216) Amber Inc. is one of the largest pharmacy retailers in mid-America. In its 2018 annual
report to shareholders, it made the following disclosure:
In 2013, Amber assigned a number of leases to Bell’s Inc. and Home Stores, Inc., as part of the
sale of the Company’s former Eastern divisions. Amber is contingently liable if Bell’s and Home
are unable to continue making rental payments on these leases. In 2017, Amber recorded a pretax
charge to earnings of $42.7 million to recognize the estimated lease liabilities associated with the
Bell’s and Home bankruptcies and for a single lease from Amber’s former Georgia division. In
2018, Bell’s began the liquidation process and Home emerged from bankruptcy and, based on the
resolution of various leases, Amber reversed $12.1 million of this accrual.
Explain the accounting principle(s) that required Amber to record the $42.7 million charge in
2017 and the $12.1 million reversal in 2018.
217) Swift Drug Company is being sued this year for a wrongful death due to violation of FDA
rules. There is no doubt that Swift is guilty and the settlement is reasonably estimable at $10
billion payable evenly over 10 years starting next year. Briefly explain how Swift would address
this in its current year financial statements.