Chapter 13 Current Liabilities and Contingencies
147. Fusion, Inc. introduced a new line of circuits in 2016 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 2016.
3. What amount should Fusion report as a liability at December 31, 2016?
Answer:
Chapter 13 Current Liabilities and Contingencies
148. Barone, Inc. is involved with several situations that possibly involve contingencies. Each is
described below. Barone’s fiscal year ends December 31, and the 2016 financial statements
are issued on March 1, 2017.
1. At March 1, 2017, 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 2015, 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, 2017, 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,
2017, 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.
Chapter 13 Current Liabilities and Contingencies
Chapter 13 Current Liabilities and Contingencies
149. At the beginning of 2016, 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 2016 were $270
million. Thirteen percent of the units sold were returned in 2016 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, 2016.
Show calculations.
150. Yummy Rice Cereal offers an all-star bowl in exchange for three coupons. Yummy Rice
estimates that 30% of coupons will be redeemed. The bowls cost Yummy Rice $1 each. In
2016, 5,000,000 coupons were distributed. By year-end 900,000 coupons had been redeemed.
Required:
Calculate the liability that Yummy Rice should report at December 31, 2016.
Chapter 13 Current Liabilities and Contingencies
151. 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 2016, 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 2016.
152. 3 Hardin Widget Manufacturing began operations in January 2016. 3 Hardin sells widgets that
carry a two-year manufacturer’s warranty against defects in workmanship. 3 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 2016 and 2017 are as follows:
2016: Sold 200 widgets on account; incurred warranty expenditures of $300.
2017: 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 2016.
2. Prepare journal entries that summarize the sales and any aspects of the warranty for 2017.
Answer:
Chapter 13 Current Liabilities and Contingencies
153. Cracker Corporation began a special promotion in July 2016 in an attempt to increase sales. A
coupon was included in various print advertisements. Customers could send in five coupons
for a free prize. Each prize cost Cracker Corporation $2.00. Cracker’s management estimated
that 70% of the coupons would be redeemed. For the six months ended December 31, 2016,
the following information is available:
Coupons distributed
2,000,000
Prizes purchased
240,000
Coupons redeemed
560,000
Required:
Record all necessary journal entries for the premium offer for 2016.
Promotional expense
Accounts receivable
($80,000 x 60% x 6%)
Warranty expense
(200 x 8% x $50)
Estimated warranty liability
Accounts receivable
(120,000 x 60% x 6%)
Warranty expense
(300 x 8% x $50)
Estimated warranty liability
154. Muller Corp. pays its employees monthly. The payroll information listed below is for January
2016, 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 2016 pay period.
Chapter 13 Current Liabilities and Contingencies
Essay
Instructions:
The following answers point out the key phrases that should appear in students’ answers. They are not
intended to be examples of complete student responses. It might be helpful to provide detailed
instructions to students on how brief or in-depth you want their answers to be.
155. Identify the major components included in the official definition of a liability as set forth by
Statement of Financial Accounting Concepts No. 6, “Elements of Financial Statements.”
156. Define the following:
1. Liabilities that are definite in amount.
2. Liabilities that must be estimated.
3. Liabilities that are contingent.
Answer:
Chapter 13 Current Liabilities and Contingencies
157. 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?
Answer:
158. How are customer advances and refundable deposits similar and yet different?
159. Define and distinguish between current and noncurrent liabilities.
Chapter 13 Current Liabilities and Contingencies
160. 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?
Answer:
161. 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.
Answer:
Chapter 13 Current Liabilities and Contingencies
162. Define a loss contingency and give two examples that almost always are accrued.
Answer:
163. 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.
164. Amber Inc. is one of the largest pharmacy retailers in mid-America. In its 2016 annual report
to shareholders, it made the following disclosure:
In 2011, 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
2015, 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
Chapter 13 Current Liabilities and Contingencies
single lease from Amber’s former Georgia division. In 2016, 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
2015 and the $12.1 million reversal in 2016.
165. 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.