Sound Audio manufactures and sells audio equipment for automobiles. Engineers no

Question

Sound Audio manufactures and sells audio equipment for automobiles. Engineers notified management in December 2013 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 2013 income statement? 3. What liability, if any, should Sound Audio report in its 2013 balance sheet? 4. Prepare any journal entry needed.

Explanation / Answer

It would be disclosed because Due to conservative accounting principles, loss contingencies are reported on the balance sheet and footnotes on the financial statements, if they are probable and their quantity can be reasonably estimated.

It should not put any expense on income statment as it has not been incurred yet.

The liability can be reported becuase the company is sure that it has to bear a loss of $ 2 million in coming period.

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