Information obtained prior to the issuance of the current period's financial statements of KG Company indicates that it is probable that,at the date of the financial statements,a liability will be incurred for obligations related to product warranties on products sold during the current period.During the past three years,product warranty costs have been approximately 1 1/2 percent of annual sales revenue.An estimated loss contingency should be:
A) Neither accrued nor disclosed in the financial statements.
B) Recognized as an appropriation of retained earnings.
C) Accrued in the accounts and reported in the financial statements.
D) Disclosed in the financial statements but not accrued.

Question

Quizplus · Accepted Answer

According to the information provided, it is probable that a liability will be incurred for product warranties on products sold during the current period. Therefore, under the accrual basis of accounting, a liability should be accrued in the accounts and reported in the financial statements. The estimated loss contingency should be recorded as a liability and an expense in the current period's financial statements, which will reflect the matching principle of accounting. Choice A is incorrect because a loss contingency should be recognized if it is probable and the amount can be reasonably estimated. Choice B is incorrect because recognizing the liability as an appropriation of retained earnings does not follow the accrual principle of accounting. Choice D is incorrect because disclosing the liability in the notes to the financial statements without accruing it in the accounts would be incomplete and not reflect the true financial position and performance of the company.

Information Obtained Prior to the Issuance of the Current Period's