Three
independent situations follow.
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 amount of claims
on sales for any particular period can be determined.
Situation
2
Subsequent
to the date of a set of financial statements, but before the date of
authorization for issuing the financial statements, a company enters into a
contract that will probably result in a significant loss to the company. The
loss amount can be reasonably estimated.
Situation
3
A
company has adopted a policy of recording self-insurance for any possible
losses resulting from injury to others by the company’s vehicles. The premium
for an insurance policy for the same risk from an independent insurance company
would have an annual cost of $4,000. During the period covered by the financial
statements, there were no accidents involving the company’s vehicles that
resulted in injury to others.
Instructions
Discuss
the accrual or type of disclosure that is necessary under ASPE (if any) and the
reason(s) why the disclosure is appropriate for each of the three independent
situations.
(AICPA
adapted)
Situation 1
When a company
sells a product subject to a warranty, it is probable that there will be
expenses incurred in future accounting periods relating to revenues recognized
in the current period. As such, a liability has been incurred to honour the
warranty at the same date as the recognition of the revenue. Based on prior experience
or technical analysis, the occurrence of warranty claims can be reasonably
estimated and a probable dollar estimate of the liability can be made, and the
estimated amount of the expense and related liability should be reflected in
the financial statements.
Situation 2
Even though: (1)
there is a probable loss on the contract, (2) the amount of the loss can be
reasonably estimated and (3) the likelihood of the loss was discovered prior to
the date of authorization of the financial statements, the fact that the
contract was entered into subsequent to the date of the financial statements
precludes accrual of the loss contingency in financial statements for periods
prior to the incurrence of the loss. However, the fact that a material loss has
been incurred subsequent to the date of the financial statements but prior to
their authorization should be disclosed by means of a note in the financial
statements. The disclosure should contain the nature of the contingency and an
estimate of the amount of the probable loss or a range into which the loss will
probably fall.
Situation 3
The fact
that a company chooses to self-insure the contingency of injury to others
caused by its vehicles is not enough of a basis to accrue a loss contingency
that has not occurred at the date of the financial statements. An accrual or
“reserve” cannot be made for the amount of insurance premium that would have
been paid had a policy been obtained to insure the company against this
particular risk. A loss contingency may only be accrued if prior to the date of
the financial statements a specific event has occurred that will impair an
asset or create a liability and an amount related to that specific occurrence
can be reasonably estimated. The fact that the company is self-insuring this
risk should be disclosed by means of a note to alert the financial statement
reader to the exposure created by the lack of insurance.
