a) A manufacturer gives warranties at the time of sale to purchasers of its product. Under the terms of the contract for sale, the manufacturer undertakes to make good by repair or replacement, manufacturing defects that become apparent within three years from the date of sale. On past experience, it is probable that there will be some claims under the warranties. Past experience suggests that 75% of the goods sold will have no defects, 20% will have minor defects and 5% will have major defects. If minor defects were detected in all products sold, the cost of repairs would be $1,000,000; if major defects were detected in all products sold, the cost would be $4,000,000. Requirements: 1. Do you think a provision should be recognized? Explain your decision 2. If a provision should be recognized, prepare the necessary journal entry to record the liability.
a) A manufacturer gives warranties at the time of sale to purchasers of its product. Under the terms of the contract for sale, the manufacturer undertakes to make good by repair or replacement, manufacturing defects that become apparent within three years from the date of sale. On past experience, it is probable that there will be some claims under the warranties. Past experience suggests that 75% of the goods sold will have no defects, 20% will have minor defects and 5% will have major defects. If minor defects were detected in all products sold, the cost of repairs would be $1,000,000; if major defects were detected in all products sold, the cost would be $4,000,000. Requirements: 1. Do you think a provision should be recognized? Explain your decision 2. If a provision should be recognized, prepare the necessary journal entry to record the liability.
Cornerstones of Financial Accounting
4th Edition
ISBN:9781337690881
Author:Jay Rich, Jeff Jones
Publisher:Jay Rich, Jeff Jones
Chapter8: Current And Contingent Liabilities
Section: Chapter Questions
Problem 54BE: Contingent Liabilities Many companies provide warranties with their products. Such warranties...
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Question
a) A manufacturer gives warranties at the time of sale to purchasers of its product.
Under the terms of the contract for sale, the manufacturer undertakes to make good
by repair or replacement, manufacturing defects that become apparent within three
years from the date of sale. On past experience, it is probable that there will be
some claims under the warranties.
Past experience suggests that 75% of the goods sold will have no defects, 20% will
have minor defects and 5% will have major defects. If minor defects were detected
in all products sold, the cost of repairs would be $1,000,000; if major defects were
detected in all products sold, the cost would be $4,000,000.
Requirements:
1. Do you think a provision should be recognized? Explain your decision
2. If a provision should be recognized, prepare the necessary journal entry to
record the liability.
(b) During the year ended 30 June 2014, Parent company guarantees borrowings of
Subsidiary company which amounts to $1,000,000. At the time of the guarantee,
Subsidiary’s’ financial position was sound. During the year ended 30 June 2015, the
financial condition of Subsidiary company deteriorates and at 30 June 2015
Subsidiary company files for protection from its creditors.
Requirements:
1) How should this be treated in Parent’s financial statements for the year ended
i) 30 June 2014 and
ii) 30 June 2015.
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