Question 1

TNT Construction had cash sales for the month of June totaling $43,700.TNT offers a 1-year warranty on its construction services.If TNT estimates warranty claims will equal 5% of sales,the journal entry to record the estimated warranty expense for the month is:

Accepted Answer

The estimated warranty expense for the month can be calculated by using the formula,
Estimated warranty expense = Sales x Warranty claim rate
Here, the sales for June is $43,700 and the estimated warranty claim rate is 5%, which gives us an estimated warranty expense of $2,185 ($43,700 x 0.05).

To record this expense, we need to use the accrual accounting method which requires us to create a liability called "Estimated warranty payable" and debit the "Warranty expense" account for the same amount. Thus, the journal entry to record the estimated warranty expense for the month is:
debit Warranty expense, $2,185; credit Estimated warranty payable, $2,185.

Question 2

Northwest Electric had cash sales for the month totaling $73,200.Northwest offers a 6-month warranty on its services.If Northwest estimates warranty claims will equal 2% of sales,the journal entry to record the estimated warranty expense for the month is:

Accepted Answer

The journal entry to record the estimated warranty expense for the month is to debit Warranty expense for $1,464 and credit Estimated warranty payable for the same amount. This is because the company estimates that it will have to pay out $1,464 (which is 2% of $73,200) in warranty claims, and this amount is recorded as a liability in Estimated warranty payable. The expense is recorded in Warranty expense to match the revenue earned in the same period. Neither cash nor sales revenue is affected by this transaction.

Question 3

During the month,Northwest Electric paid $582 to settle warranty claims.Northwest uses an estimated warranty account.The journal entry to record the payment would have been:

Accepted Answer

The payment of $582 to settle warranty claims represents a reduction in the estimated warranty liability that was originally recorded. Therefore, the estimated warranty payable account would be credited to reduce the balance, and cash would be debited to reflect the outflow of cash. Option A correctly reflects this entry. Option B would increase the estimated warranty liability instead of decreasing it. Option C has the accounts reversed. Option D would increase the warranty expense instead of decreasing the estimated warranty liability.

Question 4

During the month,TNT Construction paid $278 to settle warranty claims.TNT uses an estimated warranty account.The journal entry to record the claims payment would have been:

Accepted Answer

The correct entry is to debit Estimated warranty payable to reduce the liability and credit Cash to reflect the payment made.

Question 5

According to the matching principle,warranty expense must always be recorded in the same period as the related revenue.

Accepted Answer

The matching principle requires that expenses be recorded in the same period as the revenue they help to generate. Therefore, warranty expenses must be recorded in the same period as the revenue from the sale of the product that the warranty covers. This is because the warranty expense is directly related to the revenue generated from the product sale.

Question 6

Contingent liabilities represent actual-NOT potential-obligations.

Accepted Answer

Contingent liabilities represent potential obligations, which may or may not become actual liabilities depending on the outcome of a future event. Examples of contingent liabilities include pending lawsuits, warranties, and guarantees.

Question 7

Which of the following would be considered a contingent liability?

Accepted Answer

A contingent liability is a potential liability that depends on the occurrence of a future event. Pending legal action falls under the category of contingent liability as the outcome of the legal action is uncertain and can lead to a financial obligation for the company. Sales tax, mortgage, and accounts payable obligations are all current liabilities that are definite and not contingent on any future event.

Question 8

The accounting treatment of a contingent liability depends upon the likelihood of an actual obligation occurring.

Accepted Answer

The accounting treatment of a contingent liability is based on the likelihood of an actual obligation occurring. If it is probable that an actual obligation will occur and the amount can be reasonably estimated, then a liability is recognized in the financial statements. If it is only possible or remote that an actual obligation will occur, then disclosure in the notes to the financial statements is necessary, but a liability is not recognized.

Question 9

The disclosure of a contingent liability only in the footnotes designates that the possibility of an actual obligation occurring is:

Accepted Answer

Disclosure of a contingent liability in the footnotes means that there is a possibility of an actual obligation occurring, but the likelihood is not certain. If it was deemed remote, it would not need to be disclosed at all. If it was probable or certain, it would need to be recognized on the company's financial statements.

Question 10

A warranty is an example of a(n):

Accepted Answer

A warranty is an example of an estimated liability because it involves estimating future costs that a company may incur to repair or replace products under warranty.

Question 11

Warranty expense is always recorded in the period that the warranty claims are paid.

Accepted Answer

Warranty expense is recorded in the period in which the related revenue is recognized, based on estimates of expected warranty claims. The actual payment of warranty claims may occur in future periods, and is separate from the initial recognition of the warranty expense.

Question 12

Evergreen Roofing had cash sales for the month totaling $33,500.Evergreen offers a 1-year warranty on its roofing services.If Evergreen estimates warranty claims will equal 3% of sales,the journal entry to record the estimated warranty expense for the month is:

Accepted Answer

Since the estimated warranty expense is an accrual, it should be recorded as a debit to Warranty Expense and a credit to Estimated Warranty Payable, which creates a liability on the balance sheet for the potential future warranty claims. Option A is incorrect because there is no cash involved in this transaction. Option B is incorrect because a warranty payable is a liability, not an expense. Option C is incorrect because it reduces sales revenue, which is not reflective of the accrued warranty expense.

Question 13

During the month,Evergreen Roofing settled $300 in warranty claims by replacing the defective flashing.Evergreen uses an estimated warranty account.The journal entry to record the settled claims would have been:

Accepted Answer

The answer of During the month,Evergreen Roofing settled $300 in...

Question 14

A company that cosigns a loan with another company could incur a contingent liability.

Accepted Answer

When a company cosigns a loan with another company, it becomes liable for the loan if the borrower defaults. This creates a contingent liability, as the actual liability will only arise if the borrower fails to make the loan payments.

Question 15

There are times when contingent liabilities are never recorded.

Accepted Answer

Contingent liabilities are only recorded if the liability is probable and the amount can be reasonably estimated. If these conditions are not met, they are disclosed in the notes to the financial statements rather than being recorded on the balance sheet.

Question 16

Which of the following would NOT be considered a contingent liability?

Accepted Answer

A contingent liability is a potential liability that may arise from a past event but is not yet certain to occur. Pending legal action and potential fines from the EPA are examples of contingent liabilities because they are potential future obligations that may arise from past events. Cosigning a loan is also a contingent liability because there is a potential future obligation if the primary borrower defaults on the loan. However, Mortgage payable is not a contingent liability because it is an existing obligation that has already been incurred.

Question 17

If the likelihood of an obligation is remote:

Accepted Answer

When the likelihood of an obligation is considered remote, generally accepted accounting principles (GAAP) do not require any action to be taken in terms of recording or disclosing the obligation in the financial statements. This is because the chance of the event occurring and having a financial impact on the entity is considered too low to warrant reporting.

Question 18

The need to create an estimated warranty liability arises from the ________ principle.

Accepted Answer

The matching principle states that expenses should be recognized in the same period as the revenues they helped to generate. Therefore, the estimated warranty liability should be recognized in the period when the related revenue is earned, even if the warranty work may not be performed until a later period.

Question 19

Which of the following accurately describes how contingent liabilities are reported on the Balance Sheet?

Accepted Answer

The accounting treatment for contingent liabilities could vary based on the likelihood of an actual obligation occurring. If the likelihood is remote, no disclosure may be necessary. If the likelihood is possible or probable, it would be disclosed in the footnotes. If the likelihood is certain, it would be reported in the liabilities section of the balance sheet. Therefore, choice D is the correct option.

Question 20

The disclosure of a contingent liability in the footnotes and on the Balance Sheet indicates that the potential for the obligation occurring is:

Accepted Answer

The answer of The disclosure of a contingent liability in...

Quiz 9: Current Liabilities and Long-Term Debt