Question

Top Sound International designs and sells high-end stereo equipment for auto and home use. Engineers notified management in December 2018 of a circuit flaw in an amplifier that poses a potential fire hazard. Further investigation indicates that a product recall is probable, estimated to cost the company $3.2 million. The fiscal year ends on December 31.

Required:
1. Should this contingent liability be reported, disclosed in a note only, or neither?
a. Reported
b. Disclosed in a note only
c. Neither
2. What loss, if any, should Top Sound report in its 2018 income statement? Enter your answer in dollars, not in millions.
Loss to be reported: _____
3. What liability, if any, should Top Sound report in its 2018 balance sheet? Enter your answer in dollars, not in millions.
Liability to be reported: _____
4. What entry, if any, should be recorded? If no entry is required for a transaction/event, select "No journal entry required" in the first account field. Enter your answers in dollars, not in millions.

Answer 1

1. This contingent liability should be reported.

2. Loss to be reported: $3.2 million.

3. Liability to be reported: $3.2 million.

4. Debit Loss from product recall for $3,200,000; and Credit Contingent liability account for $3,200,000.

Step-by-step explanation:

1. Should this contingent liability be reported, disclosed in a note only, or neither?

Contingent liability can be described as a liability that may occur depending on the outcome of a future event that may likely not occur.

A contingent liability is qualified to be reported only if it is possible to estimate its value, and that it can be proved that the probability of occurrence of such liability is higher than 50%.

A contingent liability has a higher than 50% probability of occurrence if it its value can be estimated.

Since the value of this contingent liability has been estimated to be $3.2 million, this implies that it has a higher than 50% probability of occurrence. Therefore, this contingent liability should be reported.

2. What loss, if any, should Top Sound report in its 2018 income statement? Enter your answer in dollars, not in millions.

The rule is that if a contingent liability can be estimated and has a higher than 50% probability of occurrence, the total estimated amount should be reported as a loss or expense in the income statement and as a liability in the balance sheet.

Therefore, the loss that Top Sound should report in its 2018 income statement is $3.2 million.

3. What liability, if any, should Top Sound report in its 2018 balance sheet? Enter your answer in dollars, not in millions.

The rule is that if a contingent liability can be estimated and has a higher than 50% probability of occurrence, the total estimated amount should be reported as a loss or expense in the income statement and as a liability in the balance sheet.

Therefore, the loss that Top Sound should report in its 2018 balance sheet is $3.2 million.

4. What entry, if any, should be recorded? If no entry is required for a transaction/event, select "No journal entry required" in the first account field. Enter your answers in dollars, not in millions.

The journal entries will look as follows:

Details Debit ($) Credit ($)

Loss from product recall 3,200,000

Contingent liability account 3,200,000

(To record contingent liability from product recall.)