FAR · Select balance sheet accounts · 6 practice questions
Warranty accrual rollforward and loss contingencies ranges
Accrue assurance-type warranty costs at sale and accrue loss contingencies when probable and reasonably estimable, using the minimum of a range if no better estimate exists. Below: clear steps to apply the rules, presentation, insurance receivables, and 8 free practice questions.
Try one first
Hint
Compute the total expected warranty cost from current-year sales first, then ask how much of that obligation has already been satisfied.
Answer A. Pine Co. should accrue estimated warranty costs of $60,000 (3% of $2,000,000). The $40,000 paid during the year settles part of that obligation and reduces the liability. Therefore, the remaining warranty liability at December 31, 20X5 is $20,000.
Why not B: This is tempting because $40,000 is the amount actually spent on warranty repairs during the year, and some candidates focus on paid claims instead of the year-end obligation. It is wrong because cash payments reduce the liability rather than determine its ending balance. The ending liability is the estimated total obligation of $60,000 less the $40,000 already settled.
Why not C: This is tempting because $60,000 is the total estimated warranty cost related to 20X5 sales (3% of $2,000,000). However, the question asks for the liability remaining at year-end after claims paid during the year. After subtracting the $40,000 of warranty work already performed, only $20,000 remains as a liability.
Why not D: This is tempting if a candidate incorrectly treats warranty costs as expenses only when repairs are made or assumes no liability exists until future claims are filed. Under GAAP, an assurance-type warranty obligation is accrued when the related sales occur if it can be reasonably estimated. Because expected future costs remain after year-end, the liability is not zero.
Step by step
- Identify the warranty
Assurance-type warranties not separately priced create an expense and liability at sale. Separately priced extended warranties are service contracts that create deferred revenue.
- Present correctly
Report assurance-type warranty obligations as current accrued liabilities and noncurrent other liabilities based on expected settlement timing. Separately priced extended warranties are contract liabilities (deferred revenue), not accrued warranty liabilities.
- Compute and record
Estimate current-period warranty cost by applying the historical cost rate to sales subject to warranty. Record warranty expense and a corresponding liability.
- Roll the liability
Ending warranty liability equals beginning balance plus current-year accrual minus actual repair or replacement costs charged to the liability.
- Accrue loss ranges
When a loss is probable and only a range is estimable with no better point estimate, accrue the minimum and disclose the range and nature of the contingency.
- Record insurance recoveries
Recognize a separate insurance receivable only when reimbursement is probable and reasonably determinable. Do not offset it against the loss contingency liability.
Key points
- Actual warranty repairs reduce the liability, not current warranty expense, when the expense was accrued at sale.
- Roll forward the warranty liability: beginning balance plus current-year accrual minus claims paid.
- Present warranty obligations as current or noncurrent based on expected settlement timing.
- Separately priced extended warranties are contract liabilities, not accrued warranty liabilities.
- If only a range of loss is estimable and no amount is a better estimate, accrue the minimum and disclose the range.
- Recognize insurance receivables only when reimbursement is probable and the amount is reasonably determinable; present separately and do not net.
How the exam traps you
- Treating cash paid for repairs as current warranty expense. Charge actual repair costs against the accrued warranty liability; the expense was recognized at sale.
- Netting expected insurance recoveries against a litigation liability. Record a separate insurance receivable only when reimbursement is probable and reasonably determinable; present gross, not net.
- Using the midpoint or maximum of an estimated loss range when no amount is a better estimate. Accrue the minimum of the range and disclose the additional possible loss.
- Including costs of separately priced extended warranties in accrued liabilities. Record the consideration as deferred revenue and recognize revenue over the coverage period; do not accrue an assurance-type warranty liability for these contracts.
Question 2
Hint
Decide (1) which amount to accrue when only a loss range is available, and (2) whether an expected insurance reimbursement can be recognized prior to actual cash recovery.
Answer C. When a loss contingency is probable and only a range of loss can be estimated, GAAP requires accruing the minimum amount of the range if no amount within the range is a better estimate. An expected insurance recovery is recognized as an asset when reimbursement is probable and the amount is reasonably determinable; the insurer's written acknowledgment and prior prompt payments support recognition. Therefore Alpha should accrue $300,000, record a $225,000 insurance receivable, and report a net loss of $75,000.
Why not A: If a loss is probable and the amount is reasonably estimable (even only as a range), GAAP requires accrual of at least the minimum of the range rather than only disclosure; the stem indicates counsel provided an estimable range and management judged the loss probable.
Why not B: Using the midpoint may seem like a single sensible estimate, but GAAP requires accruing the minimum of the range when no amount within the range is a better estimate; the midpoint therefore overstates the liability and related receivable.
Why not D: Accruing the maximum overstates the liability when the minimum is the appropriate accrual, and waiting for cash ignores guidance that an expected reimbursement may be recognized as an asset when collection is probable and the amount is reasonably determinable (as supported here by the insurer's written acknowledgment and past practice).
Question 3
Hint
Separate assurance-type obligations from separately priced service contracts, and for PTO do not stop with the word "vested" if unused hours can still carry into the next period.
Answer D. Accrue the assurance-type warranty at $48,000 (3,200,000 × 1.5%), PTO at $57,000 (900 vested × $50 = 45,000; plus 240 expected carryforward hours × $50 = 12,000), and the contractual bonus at $24,000 (2,400,000 × 1%). The separately priced extended warranty is a separately sold service obligation (a contract liability), not an accrued warranty liability. Total accrued liabilities = 48,000 + 57,000 + 24,000 = $129,000.
Why not A: Tempting if a candidate treats the separately priced extended warranties like assurance warranties and adds the $30,000 estimated cost; however, separately priced service warranties create a contract liability (deferred revenue), not an accrued warranty liability at sale.
Why not B: This reflects accruing only vested PTO (900 × $50 = 45,000) and omitting the 240 carryforward hours expected to be used; accumulated compensated absences that are probable and estimable must be accrued.
Why not C: This omits the contractual bonus (or treats board ratification as a condition precedent). Because the bonus formula threshold was met at year-end and the board's January action is perfunctory, the bonus should be accrued.
Question 4
Hint
Compute the total estimated warranty obligation created by the year's sales, then ask whether the repairs paid during the year create more liability or use up part of it.
Answer D. For an assurance-type warranty, Apex should recognize estimated warranty expense and a related liability when the sales occur. The total estimated warranty obligation is $800,000 × 2.5% = $20,000. The $6,000 of repairs paid during Year 1 reduces that liability, leaving an ending warranty liability of $14,000.
Why not A: This reflects focusing only on the cash outflow during the year. The $6,000 paid reduces the liability but does not represent the remaining obligation from Year 1 sales.
Why not B: This answer adds the actual repairs paid to the estimate as if both increase the liability. In accrual accounting for assurance-type warranties, the estimate establishes the liability and subsequent repairs consume (decrease) that liability.
Why not C: This is the total estimated warranty obligation based on sales (800,000 × 2.5%), but it is incorrect as the year-end liability because Apex already paid $6,000 of claims, which should reduce the balance.
Question 5
Hint
Treat the warranty liability like a rollforward account: beginning balance, plus current-year accrual, less amounts used.
Answer B. The year-end warranty liability is the beginning balance plus the current-year accrual minus actual warranty costs charged against the liability. Crest should accrue 2% of $1,200,000, or $24,000, for Year 1 sales. The ending liability is therefore $18,000 + $24,000 - $21,000 = $21,000.
Why not A: This reflects only the current-year accrual ($24,000) less the $21,000 of actual repair costs. It is wrong because it ignores the $18,000 beginning warranty liability that carries forward into the year-end balance.
Why not C: $24,000 is the correct current-year warranty accrual based on sales, but the question asks for the ending liability. Actual warranty repairs during the year reduced the liability.
Why not D: This equals the beginning liability plus the current-year accrual (18,000 + 24,000) and is incorrect because it fails to subtract the $21,000 of warranty repairs charged against the liability during the year.
Question 6
Hint
Recall ASC 450: determine probability first, then how to measure a loss when only a range can be reasonably estimated.
Answer D. Under ASC 450, when a loss is probable and the amount can only be reasonably estimated as a range, accrue the minimum amount in that range and disclose the nature of the contingency and the possible additional loss. Here the estimated range is $200,000-$700,000, so Company X should record an accrued liability of $200,000 and disclose the remainder of the range.
Why not A: Conservative but incorrect: GAAP calls for recognizing the minimum of a reasonably estimable range (unless the minimum is not representative and another amount within the range is a better estimate), not the maximum.
Why not B: Tempting because the midpoint seems like a single best estimate, but ASC 450 does not require using the midpoint when only a range is available; accrue the minimum unless one specific amount within the range is a better estimate.
Why not C: Incorrect: when a loss is probable and can be reasonably estimated (even as a range), GAAP requires accrual rather than disclosure-only.
Common questions
When do you accrue a warranty liability?
At the time of sale for assurance-type warranties, based on expected costs from current-period sales. Later claims reduce the liability.
How do you record a probable lawsuit loss when only a range is known?
Accrue the minimum of the range if no amount is a better estimate and disclose the nature and possible additional loss up to the high end.
Can I recognize an insurance receivable for a probable lawsuit?
Yes, when reimbursement is probable and the amount is reasonably determinable. Record a separate asset and do not net it against the liability.
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