Chapter 11 - Solution Manual

The concept of objectivity is supportive of the

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supporting data. The concept of objectivity is supportive of the contention that future events will confirm
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223 the occurrence of a loss at the date of the financial statements. Of course the loss must be probable as well as estimable and justified in light of future events. Relevant accounting information can make a difference in a decision by helping users to form predictions about the outcomes of past, present, and future events or to confirm or correct prior expectations. Consequently, reasonable estimation of the probable future loss provides financial statement users with information that has predictive value, feedback value, and timeliness. Case 11-10 Situation 1 When a company sells a product subject to warranty, it is probable that there will be expenses incurred in future accounting periods relating to revenues recognized in the current period. As such, a liability has been incurred to honor the warranty at the same date as the recognition of the revenue. Based on prior experience or technical analysis, the occurrence of warranty claims can be reasonably estimated and a probable dollar estimate of the liability can be made. The contingent liability for warranties meets both of the requirements for the accrual of a loss contingency, and the estimated amount of the loss should be reflected in the financial statements. In addition to recording the accrual, it may be advisable to disclose the factors used in arriving at the estimate by means of a footnote especially when there is a possibility of a greater loss than was accrued. Situation 2 Even though (1) there is a probable loss on the contract, (2) the amount of the loss can be reasonably estimated and (3) the likelihood of the loss was discovered prior to the issuance of the financial statements, the fact that the contract was entered into subsequent to the date of the financial statements precludes accrual of the loss contingency in financial statements for periods prior to the incurrence of the loss. However, the fact that a material loss has been incurred subsequent to the date of the financial statements but prior to their issuance should be disclosed by means of a footnote in the financial statements. The disclosure should contain the nature of the contingency and an estimate of the amount of the probable loss or a range into which the loss will probably fall. Situation 3 The fact that a company chooses to self-insure the contingency of injury to others caused by its vehicles is not basis enough to accrue a loss contingency that has not occurred at the date of the financial statements. An accrual or "reserve" cannot be made for the amount of insurance premium that would have been paid had a policy been obtained to insure the company against this particular risk. A loss contingency may only be accrued if prior to the date of the financial statements a specific event has occurred that will impair an asset or create a liability and an amount related to that specific occurrence can be reasonably estimated. The fact that a company
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