ANSWERS TO QUESTIONS
17. (a) A contingency is defined as an existing condition, situation, or set of circumstances
involving uncertainty as to possible gain (gain contingency) or loss (loss contingency)
to an enterprise that will ultimately be resolved when one or more future events occur
or fail to occur.
(b) A contingent liability is a liability incurred as a result of a loss contingency.
18. A contingent liability should be recorded and a charge accrued to expense only if:
(a) information available prior to the issuance of the financial statements indicates that it is
probable that a liability has been incurred at the date of the financial statements, and
(b) the amount of the loss can be reasonably estimated.
20. The terms probable, reasonably possible, and remote are used in GAAP to denote the
chances of a future event occurring, the result of which is a gain or loss to the enterprise. If
it is probable that a loss has been incurred at the date of the financial statements, then the
liability (if reasonably estimable) should be recorded. If it is reasonably possible that a
loss has been incurred at the date of the financial statements, then the liability should be
disclosed via a footnote. The footnote should disclose (1) the nature of the contingency and
(2) an estimate of the possible loss or range of loss or a statement that an estimate cannot
be made. If the incurrence of a loss is remote, then no liability need be recorded or
disclosed (except for guarantees of indebtedness of others, which are disclosed even when
the loss is remote).
23. The expense warranty approach and the sales-warranty approach are both variations of the
accrual method of accounting for warranty costs. The expense warranty approach charges
the estimated future warranty costs to operating expense in the year of sale or
manufacture. The sales-warranty approach defers a certain percentage of the original sales
price until some future time when actual costs are incurred or the warranty expires.
25. Although the accounting for this transaction has been studied, no authoritative guideline
has been developed to record this transaction. In the case of a free ticket award, AcSEC
proposed
that
a portion of the ticket fares contributing to the accumulation of the 50,000 miles (the free
ticket award level) be deferred as unearned transportation revenue and recognized as
revenue
when
free transportation is provided. The total amount deferred for the free ticket should be
based
on the revenue value to the airline and the deferral should occur and accumulate as
mileage is accumulated.
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 13-13
2012
Warranty Expense ...........................................................
70,000
Inventory .....................................................................
70,000
12/31/12 Warranty Expense ...........................................................
400,000
Warranty Liability ...........................................................
400,000
BRIEF EXERCISE 13-14
(a)
(b)
(c)
Cash..................................................................................
1,980,000
Unearned Warranty Revenue
(20,000 X $99) .......................................................
1,980,000
Warranty Expense ...........................................................
180,000
Inventory .................................................................
180,000
Unearned Warranty Revenue ..........................................
330,000
Warranty Revenue
($1,980,000 X 180/1,080*) .....................................
330,000
*180,000 + 900,000
SOLUTIONS TO EXERCISES
EXERCISE 13-11 (15–20 minutes)
(a)
(b)
Cash..................................................................................
3,000,000
Sales Revenue (500 X $6,000) ................................
3,000,000
Warranty Expense ...........................................................
30,000
Inventory .................................................................
30,000
Warranty Expense ...........................................................
90,000
Warranty Liability
($120,000 – $30,000) ............................................
90,000
Cash..................................................................................
3,000,000
Sales Revenue ........................................................
Unearned Warranty Revenue .................................
2,840,000
160,000
Warranty Expense ...........................................................
30,000
Inventory .................................................................
30,000
Unearned Warranty Revenue ..........................................
40,000
Warranty Revenue
[$160,000 X ($30,000/$120,000)] ..........................
40,000
EXERCISE 13-13 (20–30 minutes)
(1)
The FASB requires that, when some amount within the range of
expected loss appears at the time to be a better estimate than
any other amount within the range, that amount is accrued. When
no amount within the range is a better estimate than any other
amount, the dollar amount at the low end of the range is accrued
and the dollar amount at the high end of the range is disclosed.
In this case, therefore, Maverick Inc. would report a liability of
$800,000 at December 31, 2012.
(2)
The loss should be accrued for $6,000,000. The potential
insurance recovery is a gain contingency—it is not recorded
until received. According to FASB ASC 410-30-35-8, claims for
recoveries may be recorded if the recovery is deemed probable.
(3)
This is a gain contingency because the amount to be received
will be in excess of the book value of the plant. Gain
contingencies are not recorded and are disclosed only when the
probabilities are high that a gain contingency will become reality.