Question

Cupola Awning Corporation introduced a new line of commercial awnings in 2021 that carry a two-year warranty against manufacturer's defects. Based on their experience with previous product Introductions, warranty costs are expected to approximate 4% of sales. Sales and actual warranty expenditures for the first year of selling the product were: Sales $5,000,000 Actual Warranty Expenditures $48,250 ed Required: 1. Does this situation represent a loss contingency? 2. Prepare journal entries that summarize sales of the awnings (assume all credit sales) and any aspects of the warranty that should be recorded during 2021. 3. What amount should Cupola report as a liability at December 31, 20217

Answer 1

1. Contingent liabilities should be recorded in the accounts when

1. it is probable that the future event will occur and
2. the amount of the liability can be reasonably estimated.

This means that a loss would be recorded (debit) and a liability established (credit) in advance of the settlement.

In this case the warranties are presumed to give rise to a probable liability that can be estimated.So the situation represent a loss contingenct.

2.

Particulars	Debit	Credit
Accounts Receivable	50,80,000.00
To	Sales		50,80,000.00
(Sales Recorded)
Warrenty Expenses	2,03,200.00
To	Estimated Warrenty Liability		2,03,200.00
( At 4% of sales)
Estimated Warrenty Liability	48,250.00
To	Inventory		48,250.00
( Actual warrenties claimed)

3.Estimated Warrenty liability to be 4% of sales ie 203200/-