Question

Sound Audio manufactures and sells audio equipment for automobiles. Engineers notified management in December 2021 of a circuit flaw in an amplifier that poses a potential fire hazard. An intense investigation indicated that a product recall is virtually certain, estimated to cost the company $70 million. The fiscal year ends on December 31 Required: 1. Should this loss contingency be accrued, only disclosed, or neither? 2. What loss, if any, should Sound Audio report in its 2021 income statement? 3. What liability, if any, should Sound Audio report in its 2021 balance sheet? 4. Prepare any journal entry needed Complete this question by entering your answers in the tabs below. Req 1 to 3 Req 4 Should this loss contingency be accrued, only disclosed, or neither? What loss and liability, if any, should Sound Audio report in its 2021 income statement and balance sheet respectively? (Enter your answers in millions rounded to 1 decimal place (i.e. 5,500,000 should be entered as 5.5).) 1. Loss continaencv

Answer 1

The contingent liability is based on probability of future event on the basis of past transaction.

1. The liability is accrued if at the time it is probable that the event will occur and amount can be reasonably estimated. If one or both of the mentioned criteria is not mentioned although there is reasonable possibility that loss will occur, then the disclosure note shall explain such contingent liability.

In the given case, the liability is accrued as both the mentioned criterias are met and should be disclosed properly.

2. The loss Sound Audio should report is $ 70 million.The warranty expense shall be charged to income statement which will decreased the income by $ 70 million.
3. The loss shall be payable. Hence, Sound Audio shall report $ 70 million as liability in its 2021 balance sheet.

d.

Date	Particulars	Debit	Credit
	Loss product recall	$ 70 million
	Liability product recall		$ 70 million
	(To record the loss payable after recalling product)

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