Question

Ortiz Corporation, a manufacturer of household paints, is preparing annual financial statements at December 31, 2012. Because of a recently proven health hazard in one of its paints, the government has clearly indicated its intention of having Ortiz recall all cans of this paint sold in the last six months. The management of Ortiz estimates that this recall would cost $800,000. What accounting recognition, if any, should be accorded this situation?

A) Note disclosure only
B) Appropriation of retained earnings of $800,000
C) Operating expense of $800,000 and liability of $800,000
D) No recognition

Answer 1

The accounting recognition for the situation described is option C) Operating expense of $800,000 and liability of $800,000.

Step-by-step explanation:

The accounting recognition for the situation described would be option C) Operating expense of $800,000 and liability of $800,000.

When a recall cost can be reasonably estimated and is probable, it should be recognized as an operating expense. In this case, the management of Ortiz estimates that the recall would cost $800,000, so it meets the criteria for recognition as an expense.

In addition, a liability should also be recognized for the amount of the estimated recall cost. This is because the company has a legal and moral obligation to recall the paint and bear the associated costs.