Page 384 - Accounting Principles (A Business Perspective)

9. Receivables and payables

Number of computers sold 1,000
Percent estimated to develop defects X 10%
Total estimated defective computers 100
Deduct computers returned as defective to date 40
Estimated additional number to become
defective during warranty period 60
Estimated average warranty repair cost per compute: X $ 150
Estimated product warranty payable $9,000
The entry made at the end of the accounting period is:
Product Warranty Expense (-SE) 9,000
Estimated Product Warranty Payable (+L) 9,000
To record estimated product warranty expense.
When a customer returns one of the computers purchased in 2010 for repair work in 2008 (during the warranty
period), the company debits the cost of the repairs to Estimated Product Warranty Payable. For instance, assume
that Evan Holman returns his computer for repairs within the warranty period. The repair cost includes parts, USD

40, and labor, USD 160. The company makes the following entry:
Estimated Product Warranty Payable (-L) 200
Repair Parts Inventory (-A) 40
Wages Payable (+L) 160
To record replacement of parts under warranty.

An accounting perspective:

Business insight

Another estimated liability that is quite common relates to clean-up costs for industrial pollution.

One company had the following note in its recent financial statements:
In the past, the Company treated hazardous waste at its chemical facilities. Testing of the ground
waters in the areas of the treatment impoundments at these facilities disclosed the presence of
certain contaminants. In compliance with environmental regulations, the Company developed a
plan that will prevent further contamination, provide for remedial action to remove the present
contaminants, and establish a monitoring program to monitor ground water conditions in the
future. A similar plan has been developed for a site previously used as a metal pickling facility.

Estimated future costs of USD 2,860,000 have been accrued in the accompanying financial
statements...to complete the procedures required under these plans.

When liabilities are contingent, the company usually is not sure that the liability exists and is uncertain about
the amount. FASB Statement No. 5 defines a contingency as "an existing condition, situation, or set of
circumstances involving uncertainty as to possible gain or loss to an enterprise that will ultimately be resolved
when one or more future events occur or fail to occur". 29
According to FASB Statement No. 5, if the liability is probable and the amount can be reasonably estimated,
companies should record contingent liabilities in the accounts. However, since most contingent liabilities may not

29 FASB, Statement of Financial Accounting Standards No. 5, "Accounting for Contingencies" (Stamford, Conn.,
1975). Copyright © by Financial Accounting Standards Board, High Ridge Park, Stamford, Connecticut 06905,

USA.

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