Question

Copperfield and Company has decided to provide a warranty on its products. The previous clerk left a note with the files on this new warranty on glass breakage, deciding that an entry for warranty expense was not necessary, with the following reasoning:

“Our product is the finest in the world, and thus the contingency of a warranty replacement for breakage is remote. Under accounting standards, the proper treatment for a remote likelihood of occurrence is to take no action. Accordingly, in my professional judgment, no journal entry should be made for warranty expense.”

You should review the previous clerk’s notes and evaluate the decision. After refreshing your memory on the treatment of contingent liabilities, what action will you take?

A. Make no entry, but disclose the possible warranty liability amount in the notes to the company financial statements.

B. Since there’s no way to accurately determine the amount of breakage that might occur, no entry or disclosure is required.

C.Journalize an adjusting entry debiting Product Warranty Expense and crediting Product Warranty Payable. Assume that a reasonable estimate of the warranty cost can be determined by an examination of prior breakage and replacement data.

D. Make no entry; the previous clerk is correct that there is a remote chance of any breakage.

Which answer A, B, C, or D?

Answer 1

The correct answer should be:

C.Journalize an adjusting entry debiting Product Warranty Expense and crediting Product Warranty Payable. Assume that a reasonable estimate of the warranty cost can be determined by an examination of prior breakage and replacement data.

Notes

Since the company is glass items, breakage is bound to happen. This means that the warranty replacement for breakage is sure to arise. In such a case, the company should account for warranty liability on some rational basis and show the same in its books.

Please comment in case of any issue and I will be happy to help.