Question

Lopez Corporation, a manufacturer of household paints, is preparing annual financial statements at December 31, 2011. Because of a recently proven health hazard in one of its paints, the government has clearly indicated its intention of having Lopez recall all cans of this paint sold in the last six months. The management of Lopez estimates that this recall would cost $800,000. What accounting recognition, if any, should be accorded this situation? A) No recognition B) Note disclosure only C) Operating expense of $800,000 and liability of $800,000 D) Appropriation of retained earnings of $800,000

Answer 1

Answer:

C) Operating expense of $800,000 and liability of $800,000

Explanation:

As based on accrual basis, an expense is the amount recognized and provided in the period to which it relates, if not paid then it is a liability and an expense.

Whereas a contingent liability is the one which is provided only in notes as the probability of its occurrence is estimated to be less than the probability of its non occurrence.

A contingent liability, when is sure to be incurred, and even the amount is known, then it is recorded as and when know, and not delayed.

Here, in the given instance the recall has to be made, and it is 100% sure, also the amount is know that is $800,000 and thus, it shall be provided in operating expense, and in balance sheet as a liability.