Question

Benson Company sells two products, Grey and Yellow. Each carries a 1-year warranty. 1.Product Grey—Product warranty costs, based on past experience, will normally be 1% of sales. 2.Product Yellow—Product warranty costs cannot be reasonably estimated because this is a new product line. However, the chief engineer believes that product warranty costs are likely to be incurred.

What would the accounting principle of conservatism dictate in this instance?

Answer 1

Accounting Principle of Conservatism-

Accounting conservatism is a principle that requires company accounts to be prepared with caution and high degrees of verification.

All probable losses are recorded when they are discovered, while gains can only be registered when they are fully realized.

If an accountant has two solutions to choose from when facing an accounting challenge, the one that yields inferior numbers should be selected.

Here in this case, Yellow—Product warranty costs cannot be reasonably estimated because this is a new product line. However, the chief engineer believes that product warranty costs are likely to be incurred.

So accountant should make provison of warranty in case of product yellow also.