Lopez Corporation, a manufacturer of household paints, is preparing annual financial statements at December 31, 2007.Because of a recently proven health hazard in one of its paints, the government has clearly indicated its intention of having Lopez recall all cans of this paint sold in the last six months.The management of Lopez estimates that this recall would cost $800,000.What accounting recognition, if any, should be accorded this situation?

Question

Quizplus · Accepted Answer

The estimated cost of the recall should be recognized as an operating expense and a liability on the balance sheet since it meets the definition of a liability (a present obligation resulting from a past event, the settlement of which is expected to result in an outflow of resources). It is not appropriate to simply disclose the situation in a note or appropriate retained earnings without recognizing the liability.

Lopez Corporation, a Manufacturer of Household Paints, Is Preparing Annual