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24 December, 11:46

Cupola Awning Corporation introduced a new line of commercial awnings in 2016 that carry a two-year warranty against manufacturers defects. Based on their experience, warranty costs are expected to be 5% of sales. Sales and actual warranty expenditures for the first year of selling the product were: sales = 5,000,000 and actual warranty expenditures = 37,500.

Required:

1) Does this situation represent a loss contingency? how should Cupola account for it?

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Answers (2)
  1. 24 December, 12:27
    0
    warranty expense 250,000 debit

    waranty liability 250,000 credit

    warranty liaiblity 37,500 debit

    cash 37,500 credit

    Explanation:

    The warranty expense will be 5% of sales

    5,000,000 x 5% = 250,000

    We will create a liability to represent the future expenses and when they occur we decrease the warrant liability.

    As we already declare the associate warranty expense based on sale the expenditures o ot generate an expense.
  2. 24 December, 13:10
    0
    Yes this is a loss contingency.

    when it is still an estimate then Debit warranty Expense and Credit provision for warrant liability and when it actually incurs; Debit the Provision for warranty liability and credit Bank.

    estimate; Debit warrant loss 250,000, Credit provision for warranty 250000

    actual; Debit provision for warranty loss 37500, Credit bank

    Explanation:

    this situation gives rise to a loss contingency because it is a provision for a adverse future event.

    The first entry to the estimation is a creation of the liability and the second entry is the actual payment

    5000000*0.05 = 250000
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