Presented below are three independent situations.

Situation 1: A company offers a one-year warranty for the product that it manufactures. A history of warranty claims has been compiled, and the probable amounts of claims related to sales for a given period can be determined.

Instructions

Discuss the accrual or type of disclosure necessary (if any) and the reason(s) why such disclosure is appropriate for each of the three independent sets of facts above.

A contingent liability is one that may or may not occur. This suggests that there is some doubt in documenting such liability in the financial records. This is due to the fact that a firm has no control over whether incidental responsibility occurs.

When a corporation sells a product with a warranty, it is likely that expenses related to sales reported in the current period will be incurred in a future accounting period. As a result, there has been an obligation to fulfill the warranty at the same time that the revenue is recognized.

The frequency of warranty claims can be reasonably estimated and a probabilistic dollar estimate of responsibility based on past experience or technical study. The contingency for warranty damage contingency meets both the conditions for accrual and the amount of damage required to be shown in the financial statements.

In addition to recording the accrual, it may be a good idea to note the reasons used to make the estimate, especially if the loss is likely to be larger than the estimate.