Required:

Prepare journal entries that should be recorded as a result of each of the above contingencies.

Answer:

(1.)	Loss from litigation	15,200,000
	Litigation liability		15,200,000

Note: This is a loss contingency. Bowe-Whitney can use the information occurring after the end of the year and before the financial statements are issued to determine the appropriate amount. A disclosure note is also appropriate.

2. No entry. This is a loss contingency but cannot be accrued unless it is both probable and reasonably estimable. Costs cannot be adequately predicted. A disclosure note is appropriate.

2. No entry. This is a loss contingency but cannot be accrued unless it is both probable and reasonably estimable. It is only reasonably possible, not probable, that a loss will result. A disclosure note is appropriate.

2. No entry. This is an unasserted assessment. It must first be probable that an assessment will be made, and then cannot be accrued unless it is both probable and reasonably estimable that the assessment will result in a loss. It is only reasonably possible, not probable, that an assessment will be made. A disclosure note is not indicated.

Learning Objective: 5 Level of Learning: 3

119. At the beginning of 2006, Scarlet Industries began offering a 3-year warranty on its products. The warranty program was expected to cost Scarlet 2% of net sales, approximately equally over the three-year warranty period. Net sales made under warranty in 2006 were $270 million. Thirteen percent of the units sold were returned in 2006 and repaired or replaced at a cost of $2 million. This amount was debited to warranty expense as incurred.

Required:

Prepare the appropriate adjusting entry to adjust warranty expense on December 31, 2006. Show calculations.

Answer:

($ in millions)
Warranty expense	3.4
Estimated warranty liability		3.4
Calculation: ($270 x 2%) - $2.0 = $3.4

Learning Objective: 6 Level of Learning: 3

120. Concept 1 Office Products sells office electronics that carry a 60-day manufacturer's warranty. At the time of purchase, customers are offered the opportunity to also buy a 1-year or 2-year extended warranty for an additional charge.

Required:

1. Does this situation represent a loss contingency?

2. Provide pro forma journal entries for the extended warranty sales and revenue recognition.

Answer:

1. This is not a loss contingency. An extended warranty is priced and sold separately from the warranted product and therefore, essentially constitutes a separate sales transaction. Since the earning process for an extended warranty continues during the contract period, revenue should be recognized over the same period. Revenue from separately priced extended warranty contracts are deferred as a liability at the time of sale, and recognized over the contract period on a straight-line basis.

2. Sale of extended warranty:

Cash	XX
Unearned revenue		XX

Adjusting journey entry in each period of the warranty to recognize revenue:

Unearned revenue	XX
Extended warranty revenue		XX

Learning Objective: 5 Level of Learning: 3

121. Yummy Rice Cereal offers a all-star bowl in exchange for 3 return box tops. Yummy Rice estimates that 30% will be redeemed. The bowls cost Yummy Rice $1 each. In 2006, 5,000,000 boxes of cereal were sold. By year-end 900,000 box tops had been redeemed.