Question

Cupola Awning Corporation introduced a new line of commercial awnings in 2016 that carry a two-year warranty against manufacturers defects. Based on their experience, warranty costs are expected to be 5% of sales. Sales and actual warranty expenditures for the first year of selling the product were:
sales = 5,000,000 and actual warranty expenditures = 37,500.

Required:

1) Does this situation represent a loss contingency? how should Cupola account for it?

Answer 1

Answer:

Yes this is a loss contingency.

when it is still an estimate then Debit warranty Expense and Credit provision for warrant liability and when it actually incurs; Debit the Provision for warranty liability and credit Bank.

estimate ; Debit warrant loss 250,000, Credit provision for warranty 250000

actual ; Debit provision for warranty loss 37500, Credit bank

Explanation:

this situation gives rise to a loss contingency because it is a provision for a adverse future event.

The first entry to the estimation is a creation of the liability and the second entry is the actual payment

5000000*0.05= 250000

Answer 2

Answer:

warranty expense 250,000 debit

         waranty liability    250,000 credit

warranty liaiblity     37,500 debit

                 cash               37,500 credit

Explanation:

The warranty expense will be 5% of sales

5,000,000 x 5% = 250,000

We will create a liability to represent the future expenses and when they occur we decrease the warrant liability.

As we already declare the associate warranty expense based on sale the expenditures o ot generate an expense.