Question 1

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

Accepted Answer

This statement is true. The matching principle requires that expenses be recorded in the same period as the related revenue they generate. In the case of a warranty, the expense should be recognized in the same period as the sale of the product, as the warranty is part of the cost of goods sold.

Question 2

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

Accepted Answer

The accounting treatment for contingent liabilities could be A (not reported), B (disclosed in footnotes only), or C (reported in liabilities section) depending on the likelihood of an actual obligation occurring. If it is probable that the obligation will become actual and the amount can be reasonably estimated, the liability will be recognized on the balance sheet. If the likelihood is uncertain or remote, the contingency will only be disclosed in footnotes. If the likelihood is reasonably possible but not probable, it may or may not be recognized on the balance sheet depending on the specific circumstances.

Question 3

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

Accepted Answer

The disclosure of a contingent liability only in the footnotes indicates that the possibility of an actual obligation arising is possible, but not probable or certain. The liability depends on future events, such as the outcome of a lawsuit, and there is a chance that it may not materialize. Therefore, it is classified as contingent and disclosed in the footnotes as a footnote disclosure.

Question 4

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

A contingent liability is disclosed in the footnotes and on the Balance Sheet when it is probable that the obligation will occur and the amount can be reasonably estimated.

Question 5

KLR Oil Company is being investigated, following an explosion on one of their oil rigs. They have multiple prior citations for safety violations, and this explosion killed several workers. The related damages are still unknown and cannot be reasonably estimated. What accounting treatment should KLR use for the investigation?

Accepted Answer

According to the accounting standard ASC 450-20, when the likelihood of an obligation occurring is probable, it should be recognized as a liability and disclosed in the financial statements. In this case, the investigation is being conducted due to safety violations and an explosion resulting in the deaths of several workers. Therefore, it is probable that KLR Oil Company will have an obligation to pay damages. However, since the amount is still uncertain, it should be disclosed in the footnotes. Choice A and B are incorrect because ASC 450-20 requires recognition when the likelihood of an obligation is probable, regardless of the amount involved. Choice D is incorrect because the likelihood of the obligation occurring is more than just reasonably possible based on the given facts.

Question 6

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

Accepted Answer

Warranty expense is estimated and recorded in the period in which the product is sold, not in the period that the warranty claims are paid. The actual payment of the claims is recorded as a reduction in the warranty liability.

Question 7

During the month, Evergreen Roofing settled $600 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 $600...

Question 8

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

Accepted Answer

The matching principle in accounting requires that expenses be matched with the revenues they help to generate. Creating an estimated warranty liability allows for the matching of the expense of the warranty (a future cost) with the revenue from the sale of the product, adhering to this principle.

Question 9

Southeast Plumbing had cash sales for the month totaling $732,000. Southeast offers a 6-month warranty on its services. If Southeast estimates warranty claims will equal 3% 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 and credit Estimated warranty payable. This is because the estimated warranty expense is an expense that needs to be recognized in the current period, and the estimated warranty payable is a liability that needs to be recorded for the estimated cost of future warranty claims. The other options are not correct because Cash and Sales revenue are not affected by the estimated warranty expense, and debiting Warranty expense and crediting Warranty expense would result in a net zero impact on the financial statements.

Question 10

During the month, Southeast Plumbing paid $600 to settle warranty claims. Southeast uses an estimated warranty account. The journal entry to record the payment would have been:

Accepted Answer

The correct journal entry to record the payment of warranty claims when using an estimated warranty account is to debit the Estimated Warranty Payable account and credit Cash. This reflects the reduction in the liability for estimated warranties and the outflow of cash to settle the claims.

Question 11

TNT Construction had cash sales for the month of June totaling $44,000. 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 journal entry to record the estimated warranty expense for the month is to debit Warranty expense for $2,200 and credit Estimated warranty payable for $2,200. This is because the estimated warranty expense is an expense item, which should be debited, and the amount of the estimated warranty payable is a liability to the company, which should be credited. Options A and D are incorrect because they do not record the estimated liability. Option B is incorrect because it credits the Warranty expense account, which is not appropriate as this is an expense account.

Question 12

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

Accepted Answer

When a company cosigns on a loan for another company, they become liable for the payment of the loan in case the borrowing company defaults. This liability is known as a contingent liability since it depends on the occurrence of an uncertain event (default by the borrowing company).

Question 13

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 determined by the probability of a future event occurring. If the likelihood is probable and the amount can be reasonably estimated, it should be recognized as a liability on the balance sheet. If the likelihood is possible or remote, it should be disclosed in the notes to the financial statements. If the likelihood is remote and the amount cannot be reasonably estimated, no disclosure is required.

Question 14

Evergreen Roofing had cash sales for the month totaling $42,000. 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

The best choice for the journal entry to record the estimated warranty expense is option D, which is to debit warranty expense and credit estimated warranty payable for $1,260. This is because the estimated warranty expense of $1,260 is an expense that needs to be recognized when revenue is earned (in this case, during the month of cash sales). Therefore, it should be debited to the warranty expense account. Additionally, because warranty claims are estimated to equal 3% of sales, the amount of estimated warranty payable needs to be credited for the same amount to reflect the fact that some future warranty claims will be paid out. Option B is also a valid choice, but it is less specific, as it only credits warranty payable rather than estimated warranty payable.

Question 15

During the month, TNT Construction paid $300 to settle warranty claims. TNT uses an estimated warranty account. The journal entry to record the claims payment would have been:

Accepted Answer

When a company pays off warranty claims, it decreases its liability (Estimated Warranty Payable) and its cash. The correct entry is to debit (decrease) the Estimated Warranty Payable account and credit (decrease) Cash.

Question 16

Contingent liabilities represent actual-NOT potential-obligations.

Accepted Answer

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

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

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

Accepted Answer

A contingent liability is a potential obligation that may or may not occur in the future, depending on the outcome of a specific event. Pending legal action, potential fines from the EPA, and cosigning a loan are all examples of contingent liabilities, as they represent potential future obligations that are dependent on certain conditions being met. Mortgage payable, on the other hand, is a current liability that represents a debt that is already owed and therefore would not be considered a contingent liability.

Question 19

When a company settles a warranty claim by replacing the defective goods, the journal entry will include a debit to _______ and a credit to _______.

Accepted Answer

When a company settles a warranty claim by replacing defective goods, it debits (reduces) the Estimated Warranty Payable account because it is fulfilling its obligation under the warranty, and credits (reduces) Inventory because it is using its inventory to replace the defective goods.

Question 20

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.

Quiz 9: Current Liabilities and Long-Term Debt