Question

Sound Audio manufactures and sells audio equipment for automobiles. Engineers notified management December 2011 of a circuit flaw in an amplifier that poses a potential fire hazard. An intense investigation indicated that a product recall is virtually certain, estimated to cost the company $2 million. The fiscal year ends on December 31.
Required:
1. Should this loss contingency be accrued, disclosed only, or neither? Explain.
2. What loss, if any, should Sound Audio report in its 2011 income statement?
3. What liability, if any, should Sound Audio report in its 2011 balance sheet?
4. Prepare any journal entry needed.

Answer 1

Answer:

1. Accrued

2. $2 Million

3. $2 Million

4. Dr Loss product recall (Expense) $2 Million

Cr Liability product recall (Liability) $2 Million

Explanation:

1. Yes, Based on the information given this loss contingency should be accrued reason been that all the necessary requirement are met and secondly the loss is tend to be probably and lastly the said amount can be estimated which is why the recorded liability is accrued.

2. The loss that Sound Audio should report in its 2011 income statement is $2 Million

3. The liability that Sound Audio should report in its 2011 balance sheet would also be $2 Million

4.Preparation of any journal entry needed

Dr Loss product recall (Expense) $2 Million

Cr Liability product recall (Liability) $2 Million