Angela Company is a manufacturer of toys. During the year, the following situati
ID: 2470803 • Letter: A
Question
Angela Company is a manufacturer of toys. During the year, the following situations arose:
1. A safety hazard related to one of its toy products was discovered. It is considered probable that liabilities have been incurred. Based on past experience, a reasonable estimate of the amount of loss can be made.
2. One of the firm's small warehouses is located on the bank of a river and can no longer be insured against flood losses. No flood losses occurred after the date the insurance became unavailable.
3. This year, Angela began promoting a new toy by including a coupon, redeemable for a movie ticket, in each toy's carton. The movie ticket, which cost Angela $2, is purchased in advance and then mailed to the customer when Angela receives the coupon. Based on past experience, Angela estimated that 60 percent of the coupons would be redeemed. Forty percent of the coupons would be actually redeemed this year, and the remaining 20 percent of the coupons were expected to be redeemed next year.
A. How should Angela report the safety hazard? Why? Do not discuss deferred tax implications.
B. How should Angela report the uninsured flood risk? Why?
C. How should Angela account for the toy-promotion campaign in this year?
Explanation / Answer
A. The safety hazard liability is probable and the liability amount can be ascertained based on past experience.
So the contingent laibility needs to be recognized and recorded in the financials this year.
B. The possibility of flood is nor remote and as there is no insurance against flood loss , there is a possibilty that there may be economic outflow due to flood loss. As the estimate cannot be made precisely , the contingent liability of a flood loss needs to be disclosed in the Notes to Financial statements.
C. The cost per coupon is $2 and the probability of redemption is 60%. So $2*60% =$1.20 per unit og toy sold needs to be accounted as Toy Promotion expense and same amount of liability has to be recognized in the year.
Actual redemption expenses will be credited to CAsh and debited to Liability expense as and when the coupons are redeemed.