1. Identify the three levels of contingent liabilities and the respective accounting treatments.
Long-Run Motors, Inc. manufactures durable automobiles with 3-year bumper-to-bumper warranties. During 2014 (the first year of operations), Long-Run sells 100,000 automobiles with the following expected future warranty claims:
|
Year
|
Expected cost of claims
|
Probability
|
|
|
$25,000
|
15%
|
|
2015
|
$75,000
|
50%
|
|
|
$150,000
|
35%
|
|
|
|
|
|
|
$40,000
|
25%
|
|
2016
|
$100,000
|
35%
|
|
|
$120,000
|
40%
|
|
|
|
|
|
|
$60,000
|
15%
|
|
2017
|
$120,000
|
40%
|
|
|
$150,000
|
45%
|
2. At December 31, 2014, why will Long-Run report a liability for warranty claims?
3. What will Long-run report as the total warranty liability (ignore current vs. non-current classification) at December 31, 2014 if the risk-adjusted discount rate is 10%? Assume Long-Run settles any claims at the end of the years (i.e., December 31).
4. In January 2014, ABC Inc. receives notice that a customer will be filing (but has not yet filed) a product liability lawsuit against the firm. If the plaintiff's injuries occurred during 2013, and ABC will issue the 2013 financial statements on February 28, 2014, will the 2013 balance sheet include a liability for injuries associated with the lawsuit? Why or why not?
5. GAAP requires the recognition of expected probable losses, and generally prohibits the recognition of expected probable gains. Why is GAAP requiring the recognition of the losses earlier than the gains?