Fusion, Inc. introduced a new line of circuits in 2016 that carry a four-year warranty against manufacturer's defects. Based on experience with previous product introductions, warranty costs are expected to approximate 3% of sales. Sales and actual warranty expenditures for the first year of selling the product were:

Actual warrantySales Expenditures$15 million $200,000Does this situation represent a loss contingency? Why or why not? How should it be accounted for?

Question

Business

Nathaniel Woodard

10 July, 09:52

Fusion, Inc. introduced a new line of circuits in 2016 that carry a four-year warranty against manufacturer's defects. Based on experience with previous product introductions, warranty costs are expected to approximate 3% of sales. Sales and actual warranty expenditures for the first year of selling the product were:

Actual warrantySales Expenditures$15 million $200,000Does this situation represent a loss contingency? Why or why not? How should it be accounted for?

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Answers (1)

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Terrell Woodard · Answer 1

For Fusion inc.

Actual warranty in 2016:

Expenditure = $200,000

Sales = $15,000,000

Warranty provision at 3% of sales = (3/100) * $15,000,000 = $450,000.

Due to the possibility of future liability depending on some future possible events, the situation represents a loss contingency.

Nevertheless, as the amount of liability can be estimated and the liability is probable, the liability needs to be recognized in the financial statements.