ICE - Ch 13-2 - 240125

pdf

School

San Diego Miramar College *

*We aren’t endorsed by this school

Course

334

Subject

Accounting

Date

Apr 3, 2024

Type

pdf

Pages

Uploaded by KidEnergy7013

In-Class Exercise What are Liabilities again (3 criteria)? What if there was a past transaction/event, and the present obligation is uncertain because it depends on a future event? CONTINGENT LIABILITIES Amount of Potential Loss Likelihood Known Reasonably Estimable Not Reasonably Estimable Probable Reasonably Possible Remote Examples Warranties Litigation What if no claim has been made for a past event? What if it is a gain?

Exercise 1 Ajlouni Air Corporation sells central home air conditioning units under a 2-year warranty contract that requires the corporation to replace defective parts and to provide the necessary repair labor. During 2024, the corporation sells for cash 1,550 air conditioning units at a unit price of $4,210 (cost to Ajlouni equalled $3368). Based on past experience, the 2-year warranty costs are estimated to be $115 for parts and $165 for labor per unit. (For simplicity, assume that all sales occurred on December 31, 2022.) The warranty is not sold separately from the air conditioning units, and Ajlouni expects to incur 34%of the warranty expense in the first year. Instructions a. Record any necessary journal entries in 2024, applying the expense warranty accrual method. b. What liability relative to these transactions would appear on the December 31, 2024, balance sheet and how would it be classified if the expense warranty accrual method is applied? In 2025, the actual warranty costs to Ajlouni Air Corporation were $73,083 for parts and $102,300 for labor. c. Record any necessary journal entries in 2025, applying the expense warranty accrual method.

Exercise 2 You are the independent auditor engaged to audit Abdi Corporation, in preparation of its December 31, 2024, financial statements. During the course of your audit, you discovered the following contingent liabilities. 1. As a result of uninsured accidents during the year, personal injury suits for $345,000 and $675,000 have been filed against the company. It is the judgment of Abdi's legal counsel that an unfavorable outcome is unlikely in the $345,000 case but that an unfavorable verdict approximating $575,000 will probably result in the $675,000 case. 2. Abdi's deep sea exploration division consisting of operations in the Marina Trench is uninsurable because of the special risk of injury to employees and losses due to high pressure. The year 2024 is considered one of luckiest in the division’s history because no loss due to injury or casualty was suffered. Having suffered an average of two casualties a year during the rest of the past decade (ranging from $25,000 to $1,000,000), management is certain that next year the company will probably not be so fortunate. 3. Abdi Corporation owns a subsidiary in a foreign country that has a book value of $21,500,000 and an estimated fair value of $31,250,000. The foreign government has communicated to Starfish its intention to expropriate the assets and business of all foreign investors. On the basis of settlements other firms have received from this same country, Abdi expects to receive 55% of the fair value of its properties as final settlement. 4. Abdi is the defendant in a patent infringement lawsuit by Gonzalez, Inc. over Abdi‘s use of a propeller design in its deep sea submersible. Abdi’s general counsel claims that, if the suit goes against Abdi, the loss may be as much as $26,000,000; however, their attorney believes the loss of this suit to be only reasonably possible. Again, no mention of this suit is made in the financial statements. 5. Abdi’s general counsel has informed you that Abdi has been cited for burying toxic chemicals behind one of the plants. Clean-up costs and fines amount to $7,500,000. Although the case is still being contested, their attorney is certain that Abdi will most probably have to pay at least $4,350,000 of the fine and clean-up costs. No disclosure of this situation was found in the financial statements. As presented, these contingencies are not reported in accordance with GAAP, which may create problems in issuing a favorable audit report. You feel the need to note these problems in the work papers. Instructions Indicate what should be reported relative to each situation in the financial statements and accompanying notes. If required, prepare the journal entries that should be recorded as of December 31, 2024, to recognize each of the situations above.

Your preview ends here

Eager to read complete document? Join bartleby learn and gain access to the full version