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 $3.0 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.

Answer 1

1

This situation represent a loss contingency

As the chances are probable and amount can be reasonably estimated, this represents a loss contingency and should be accrued.

The loss contingency should be accrued & disclosed.

2
Loss	3 million
3
Liability	3 million
4
	Debit	Credit
Loss-Product recall	3
Liability-Product recall		3