Question

15. Constructive obligations may arise from:
A. Accrued Liabilities resulting from operations.
B. Warranty obligations.
C. Notes Payable.
D. Unearned Revenues.

16. A company had sales of $1 million. Coupons in the amount of $1 per $10 in sales were given to paying customers. History has shown that 50% of all coupons are redeemed. Which of the following statements is correct?
A. A provision for $50,000 must be recognized.
B. A provision for $100,000 must be recognized.
C. A provision for $1 million must be recognized.
D. No provision is necessary.

Answer 1

15. The correct answer is Option B, i.e. Warranty Obligations.
Explanation : "Constructive Obligation" is a situation when the business entity has given others reasons to believe that entity has undertaken an obligation and will settle the same. When an entity gives warranty for it products that it will do the necessary repair or replace a product during its warranty period, then it constitute a constructive obligation.

16. The correct answer is Option A, i.e. A provision for $50000 must be recognized.
Explanation : The coupons are used in purchases that will be made in future and is uncertain. So, in this case, the company has to make a provision of expected liability based on best estimates, and accordingly adjust with the actual liability which will arise in future. Therefore, the company needs to make a provision of $50000 which is 50% of the coupon value, i.e. $100000.