Question

Cupola Awning Corporation introduced a new line of commercial awnings in 2021 that carry a two-year warranty against manufacturer’s defects. Based on their experience with previous product introductions, warranty costs are expected to approximate 2% of sales. Sales and actual warranty expenditures for the first year of selling the product were:

Sales	Actual Warranty Expenditures
$5,340,000	$49,500

Required:
1. Does this situation represent a loss contingency?
2. Prepare journal entries that summarize sales of the awnings (assume all credit sales) and any aspects of the warranty that should be recorded during 2021.
3. What amount should Cupola report as a liability at December 31, 2021?

Answer 1

1. This is a loss contingency because it meets the definition of a loss contingency: It is an existing condition with uncertainty relating to possible gain or loss based on future events. the liability is probable and can be reasonably estimated so the liability must be accrued.

2. Sales:
Dr. Accounts receivable 5,340,000
Cr. Sales revenue 5,340,000

Actual expenditures:
Dr. Warranty liability - 49500
Cr. cash - 49500

working for accrued liability and expense:
warranty expense(2% X 5.340 mil) 106800
warranty liability 106800

3. Amount Cupola report as a liability at December 31, 2021 is the ending balance which is calculated as Accrued warranty liability less the actual warranty expenditure paid

106800 - 49500 = 57300