Information obtained prior to the issuance of the current period's financial statements of a company indicates that it is probable that,at the date of the financial statements,a liability will be incurred for obligations related to product warranties on products sold during the current period.During the past three years,product warranty costs have been approximately 1 1/2 percent of annual sales revenue. An estimated loss contingency should be
A) neither accrued nor disclosed in the financial statements.
B) recognized as an appropriation of retained earnings.
C) accrued in the accounts and reported in the financial statements.
D) disclosed in the financial statements but not accrued.

Question

Quizplus · Accepted Answer

According to the information obtained prior, it is probable that a liability will be incurred for obligations related to product warranties on products sold during the current period. Therefore, an estimated loss contingency should be accrued in the accounts and reported in the financial statements. This is in accordance with the accounting principle of accruals and the matching concept, which requires that expenses be recognized when they are probable and can be reasonably estimated. The estimated loss contingency should be disclosed in the notes to the financial statements as well. Option A is incorrect because a liability is probable and can be reasonably estimated. Option B is incorrect because recognizing a loss contingency as an appropriation of retained earnings is inappropriate as it doesn't fall under the criteria of appropriation. Option D is incorrect because disclosing the contingency without recognition in the financial statements would make the financial statements misleading.

Information Obtained Prior to the Issuance of the Current Period's