Question

Omez Corporation, a manufacturer of household paints, is preparing annual financial statements at December 31, 2011. Because of a recently proven health hazard in one of its paints, the government has clearly indicated its intention of having Gomez recall all cans of this paint sold in the last six months. The management of Gomez estimates that this recall would cost $800,000.

part A- what accounting recognition if any should be accorded this situation?

Part b- how would your answer change to part a if 70% of the paint cans were sold before 12/31/2011 and the remainder were sold after 12/31/2011 but before the financial statements were issued on 3/5/2012.

Part C-how would your answer change to part a if the health hazard was only alleged (but not yet probable) when the 2011 financial statements were published.

Answer 1

First Scenario

Pass the following entries

Debit Product recall expense $800,000

Credit Recall liabilities $800,000

Second Scenario

Pass the following entries

Debit Product recall expense $800,000

Credit Recall liabilities $800,000

Third Scenario

Disclose in notes to the accounts

Step-by-step explanation:

According to the US GAAP ,"this question relates to contingent liabilities are a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity"

First Scenario

The estimates of recall cost will be provided for by:

Debit Product recall expense $800,000

Credit Recall liabilities $800,000

Second Scenario

The 70% of the estimated cost will be recorded as an expense and liability as above as well the balance of 30%,the reason is that the sales of the remaining 30% even though took in place in the current year but the accounts for last year have not be finalized,that it is an event after reporting period that should be captured in previous year accounts.

Third Scenario

As the health hazard is just a mere a allegation,disclosing the incident by a way of note to the accounts will be sufficient for now.