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 $2.0 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. Yes, a liability is accrued if it is probable that the confirming event will occur and the amount can be estimated reasonably. If one or both of these criteria is not met but is is possible that a loss will occur then a disclosure note is required and should describe the contingency.

But in this case both the criteria are met the loss ks probably and the amount can be estimated so we will record the liability and the liability is accrued.

2. The loss would be the reasonable estimate pf the loss which is $2 Million.

3. the liability would also be $2 Million

4. Dr. Loss product recall (Expense) - $2 Million

Cr. Liability product recall (Liability) - $2 Million

Expense will go to income statement and accrued loss liability will go to Balance sheet.