Question

How do you account for gain contingencies (recording, disclosing, neither)?

Warranty expense and warranty liability calculation for assurance type warranty?

Warranty expense, warranty revenue, and warranty unearned revenue calculation?

Answer 1

Contingencies. A contingency poses a different reporting quandary. A past event has occurred but the amount of the present obligation (if any) cannot yet be determined. With a contingency, the uncertainty is about the outcome of an action that has already taken place. The accountant is not a fortune teller who can predict the future. For example, assume Wysocki Corporation commits an act that is detrimental to the environment so that the federal government files a lawsuit for damages. The original action against the environment is the past event that creates the contingency. However, both the chance of losing the suit and the possible amount of any penalties might not be known definitively for several years. What, if anything, should be recognized in the interim?

Because companies prefer to avoid (or at least minimize) the recognition of losses and liabilities, it is not surprising that structured guidelines are needed for reporting contingencies. Otherwise, few if any contingencies would ever be reported. U.S. GAAP in this area was established in 1975 when FASB issued its Statement Number Five, “Accounting for Contingencies.” This pronouncement requires the recognition of a loss contingency if

1. the loss is deemed to be probable, and
2. the amount of loss can be reasonably estimated.

When both of these criteria are met, the expected impact of the loss contingency is recorded. To illustrate, assume that the lawsuit above was filed in Year One. Wysocki officials assess the situation. They believe that a loss is probable and that $800,000 is a reasonable estimation of the amount that will eventually have to be paid as a result of the damage done to the environment. Although this amount is only an estimate and the case has not been finalized, this contingency must be recognized.

The total amount of warranty expense is limited by the warranty period that a business typically allows. ... As actual warranty claims are received, debit the warranty liabilityaccount and credit the inventory account for the cost of the replacement parts and products sent to customers.

Warranty expense. Warranty expense is thecost that a business expects to or has already incurred for the repair or replacement of goods that it has sold. ... This is called the matching principle, where all expensesrelated to a sale are recognized in the same reporting period as the revenue from the sale transaction.