B. On December 1, 2005, Jaron Company sued Booker Company for unfair competition. Booker's lawyers believe it is probably that the company will lose the lawsuit and be assessed an amount that may range from $3 million to $7 million. If the loss is probable and the amount can be reasonably estimated, it should be recognized as a contingent liability. Booker should record the loss at $3 million, the low end of the estimate, and disclose the high end of the estimate, $7 million, in the notes. C. Booker Company is not insured against lawsuits filed by customers for defective products. During the year the company had sales of $20 million. The company anticipates that lawsuits may be filed during 2006. This is not a contingent liability and should not be recorded. A company is not re- quired to anticipate and record future events. In this case, the event or loss has not occurred. Required: How should Booker report the three contingencies on the balance sheet of December 31, 2005? Give your reasoning for your choices. (See answers in blue) Analyze: Does the principle of conservatism play a role in reporting contingencies? to the idea of conservatism when deciding whether contingencies should be recorded. The recording of a contingent liability has the effect of lowering net income, thus providing a “conservative” measurement of income for that period. Analyze: Recording of accruals is a function of matching, but the accountant also adheres
Problem 12-6 Premium Offers Goodee Cereal Company began a coupon offer in 2005. If customers send in the proof of purchase from four cereal boxes at $2,00, they can receive a CD from a new music artist. The cereal sells for $4.00 per box. Goodee expects that 70 percent of the cereal boxes will be used by customers for the redemption. During 2005 and 2006 the following events occurred: 2005 A. Sold 150,000 boxes of cereal for cash. B. Purchased 40,000 CDs at $2.50 each for cash. C. Customers sent in 100,000 proofs of purchase to receive 25,000 CDs. Mailing and shipping costs were $.80 per CD. 2006 A. Sold 200,000 boxes of cereal for cash. B. Puchased 80,000 CDs at $2.50 each for cash. C. Customers sent in 120,000 proofs of purchase to receive 30,000 CD's. Mailing and shipping costs were $.80 per CD. Required: 1 Prepare the journal entries in 2005 and 2006 to record these events. 2005: DESCRIPTION DEBIT CREDIT A. Cash (150,000 × $4) 600,000 Sales Revenue 600,000 Expense for Coupons to Be Rede 34,125 [(150,000 × 70%) ÷ 4 × $1.30*] Estimated Liability for Coupons 34,125 *$0.80 + $2.50 – $2.00 = $1.30 B. CD Inventory (40,000 × $2.50) 100,000 Cash 100,000 C. Cash (25,000 × $2) 50,000 Estimated Liability for Coupons (2 32,500 CD Inventory (25,000 × $2.50) 62,500 Cash (25,000 × $0.80) 20,000 2006: DESCRIPTION DEBIT CREDIT A. Cash (200,000 × $4) 800,000 Sales Revenue 800,000
Expense for Coupons to Be Rede 45,500 [(200,000 × 70%) ÷ 4 × $1.30] Estimated Liability for Coupons 45,500 B. CD Inventory (80,000 × $2.50) 200,000 Cash 200,000 C. Cash (30,000 × $2) 60,000 Estimated Liability for Coupons (3 39,000 CD Inventory (30,000 × $2.50) 75,000 Cash (30,000 × $0.80) 24,000 2 Determine the amounts of estimated liability for coupons that should be reported on the balance sheets of December 31, 2005 and 2006. Indicate what amounts should be current and long-term liabilities.