Question

The following selected transactions relate to contingencies of Classical Tool Makers, Inc., which began operations in July 2021. Classical's fiscal year ends on December 31. Financial statements are issued in April 2022. 1. Classical's products carry a one-year warranty against manufacturer's defects. Based on previous experience, warranty costs are expected to approximate 3% of sales. Sales were $2.8 million (all credit) for 2021. Actual warranty expenditures were $31,600 and were recorded as warranty expense when incurred. 2. Although no customer accounts have been shown to be uncollectible, Classical estimates that 2% of credit sales will eventually prove uncollectible. 3. In December 2021, the state of Tennessee filed suit against Classical, seeking penalties for violations of clean air laws. On January 23, 2022, Classical reached a settlement with state authorities to pay $2.3 million in penalties. 4. Classical is the plaintiff in a $4.8 million lawsuit filed against a supplier. The suit is in final appeal and attorneys advise that it is virtually certain that Classical will win the case and be awarded $3.3 million. 5. In November 2021, Classical became aware of a design flaw in an industrial saw that poses a potential electrical hazard. A product recall appears unavoidable. Such an action would likely cost the company $580,000. 6. Classical offered $20 cash rebates on a new model of jigsaw. Customers must mail in a proof-of-purchase seal from the package plus the cash register receipt to receive the rebate. Experience suggests that 70% of the rebates will be claimed. Ten thousand and eight hundred of the jigsaws were sold in 2021. Total rebates to customers in 2021 were $113,000 and were recorded as promotional expense when paid. Required: 1-a Prepare the year-end entries for any amounts that should be recorded as a result of each of the above contingencies. 1-b Indicate whether a disclosure note is needed for the above transactions.

Answer 1

Part 1 A

No.	Event	General journal	Debit	Credit
1	1	Warranty expense (2800000*3%)-31600	52400
		Estimated warranty liability		52400
2	2	Bad debt expense (2800000*2%)	56000
		Allowance for uncollectible accounts		56000
3	3	Loss litigation	2300000
		Liability -litigation		2300000
4	4	No journal entry required
5	5	Loss-product recall	580000
		Liability-product recall		580000
6	6	Promotional expense (70%*20*10800)-113000	38200
		Estimated premium liability		38200

Part 1 B

Event 1	No	It is a warranty expense
Event 2	No	It is a bad debt expense
Event 3	Yes	It is a loss contingency. The appropriate disclosure is required including information occurring after the end of the year and before the financial statements are issued
Event 4	Yes	It is a gain contingency. Gain is recognized when it is actually received. Thus a disclosure is required
Event 5	Yes	It is a loss liability
Event 6	No	It is promotional expense