F4 - M2 (Contingencies and Commitments)

Question 1

What’s the criteria to accrue/disclose loss contingencies?

Answer 1

Must be probable, estimable, and within the books closing date to be accrued.

However, to be disclosed it doesn’t have to be estimable or probable or before the books closed.

Question 2

What’s the criteria to accrue/disclose gain contingencies?

Answer 2

Cannot be accrued unless paid out with the year

Disclosed portion is the minimum amount to the largest amount if it is not paid out within the year.

Question 3

Delect Co. provides repair services for the AZ195 TV set. Customers prepay the fee on the standard one-year service contract. The Year 1 and Year 2 contracts were identical, and the number of contracts outstanding was substantially the same at the end of each year. However, Delect’s December 31, Year 2, deferred revenues’ balance on unperformed service contracts was significantly less than the balance at December 31, Year 1. Which of the following situations might account for this reduction in the deferred revenue balance?

Answer 3

Contract in year 2 was signed earlier lowering deferred revenue.

Question 4

Vadis Co. sells appliances that include a three-year warranty. Service calls under the warranty are performed by an independent mechanic under a contract with Vadis. Based on experience, warranty costs are estimated at $30 for each machine sold. When should Vadis recognize these warranty costs?

Answer 4

When the machines are sold. (date of sale)

The costs must be matched with the sale

Question 5

Delect Co. provides repair services for the AZ195 TV set. Customers prepay the fee on the standard one-year service contract. The Year 1 and Year 2 contracts were identical, and the number of contracts outstanding was substantially the same at the end of each year. However, Delect’s December 31, Year 2, deferred revenues’ balance on unperformed service contracts was significantly less than the balance at December 31, Year 1. Which of the following situations might account for this reduction in the deferred revenue balance?

Answer 5

Year 2 contracts were signed earlier lowering the deferred revenue amount because more of the revenue could be realized.

Year 2 Contract being signed later would of raised the deferred revenue since the revenue couldn’t of been realized.

Question 6

In Year 1, a personal injury lawsuit was brought against Halsey Co. Based on counsel’s estimate, Halsey reported a $50,000 liability in its December 31, Year 1, balance sheet. In November Year 2, Halsey received a favorable judgment, requiring the plaintiff to reimburse Halsey for expenses of $30,000. The plaintiff has appealed the decision, and Halsey’s counsel is unable to predict the outcome of the appeal. In its December 31, Year 2, balance sheet, Halsey should report what amounts of asset and liability related to these legal actions?

Asset Liability
30k $0
30k 50k
$0 20k
$0 $0

Answer 6

0 since the 50k was already settled and the 30k would be a gain contingency which should not be recorded anyway until realized.

An additional loss of 20k is void.

Question 7

During Year 1, Gum Co. introduced a new product carrying a two-year warranty against defects. The estimated warranty costs related to dollar sales are 2% within 12 months following the sale and 4% in the second 12 months following the sale. Sales and actual warranty expenditures for the years ended December 31, Year 1 and Year 2, are as follows:

Sales	Warr Expend Y1	150k	2.250k Y2	250k	7.5k
400k	9.750k

What amount should Gum report as estimated warranty liability in its December 31, Year 2, balance sheet?

Answer 7

400,000 X 0.06 = 24,000

24,000 - 9,750 = 14,425

Question 8

Marr Co. sells its products in reusable containers. The customer is charged a deposit for each container delivered and receives a refund for each container returned within two years after the year of delivery. Marr accounts for the containers not returned within the time limit as being retired by sale at the deposit amount. Information for Year 3 is as follows:

Container deposits at December 31, Year 2 from deliveries in:
Y1 150k
Y2 430k

Deposits for containers delivered in Year 3 780,000

Deposits for containers returned in Year 3 from deliveries in:
Year 1 90k
Year 2 250k
Year 3 286k

In Marr’s December 31, Year 3 balance sheet, the liability for deposits on returnable containers should be:

Answer 8

150,000 - 90,000 = 60,000 (with 60,000 expired since two years passed)

430,000 - 250,000 = 180,000

780,000 - 286,000 = 494,000

180,000 + 494,000 = 674,000

Question 9

The Bake Shop sold 750,000 boxes of cake mix during the year under a new sales promotion program. Each box contains one coupon that, submitted with $4.00, entitles the customer to a baking pan. The Bake Shop pays $5.00 per pan and $.50 for handling and shipping. The Bake Shop estimates that 80% of the coupons will be redeemed, even though only 450,000 coupons had been processed during the year. What amount should The Bake Shop report as a liability for unredeemed coupons at year-end?

Answer 9

750,000 X 0.8 = 600,000

600,000 - 450,000 = 150,000

150,000 X 1.50 = 225,000

Question 10

On November 1, Year 2, Davis Co. discounted with recourse at 10% a one-year, noninterest bearing, $20,500 note receivable maturing on January 31, Year 3. What amount of contingent liability for this note must Davis disclose in its financial statements for the year ended December 31, Year 2?

A.	 $20,000

B.	 $20,333

C.	 $0

D.	 $20,500

Answer 10

Full 20,500 since Davis is responsible for the default. With recourse means the seller (davis) is responsible

Question 11

On October 1, the State Environmental Board issued a fine for $900,000 for clean air violations. We believe that a loss is probable and that the fine will be reduced to an amount between $200,000 and $500,000. No specific amount in the range can be judged as the best estimate.

This letter serves as notice that you are being assessed a fine of $300,000 related to violations of state clean air codes that were identified on October 1, Year 1, at your manufacturing facility located at 321 Mountain View Road, East Hills, CA 95432.

Our follow-up inspection on December 29, Year 1, indicated that the violations were appropriately remediated, and there were no outstanding code violations at that time.

Does this need to be accrued? If so how much? What about disclosed?

Answer 11

Email states after YE

Disclosed 300,000 Accrual since the email is before FS issued and was officially adjourned

Question 12

Vadis Co. sells appliances that include a three-year warranty. Service calls under the warranty are performed by an independent mechanic under a contract with Vadis. Based on experience, warranty costs are estimated at $30 for each machine sold. When should Vadis recognize these warranty costs?

A.	 Evenly over the life of the warranty.

B.	 When payments are made to the mechanic.

C.	 When the service calls are performed.

D.	 When the machines are sold.

Answer 12

When the machines are sold.

since it is warrant costs must be accounted for when the machines are sold.