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Current liabilities and contingencies - Journal Entries

Please show work and follow GAAP unless otherwise stated

The following selected transactions relate to contingencies of Eastern Products Inc. which began operations in July, 2006. Eastern's fiscal year ends on December 31. Financial statements are published in April 2007.

(a) No customer accounts have been shown to be uncollectible as yet, but Eastern estimates that 4% of credit sales will eventually prove uncollectible. Sales were $300 million (all credit) for 2006.

(b) Eastern offers a one-year warranty against manufacturer's defects for all its products. Industry experience indicates that warranty costs will approximate 2% of sales. Actual warranty expenditures were $4.0 million in 2006 and were recorded as warranty expense when incurred.

(c) In December 2006, Eastern became aware of an engineering flaw in a product that poses a potential risk of injury. As a result, a product recall appears inevitable. This move would likely cost the company $2.3 million.

(d) In November 2006, the State of Vermont filed a suit against Eastern, asking for $5 million in civil penalties and injunctive relief for violations of clean water laws. On February 3, 2007, Eastern reached a settlement with state authorities to pay $3.8 million in penalties.

(e) Eastern is the plaintiff in a $40 million lawsuit filed against a customer for costs and lost profits from contracts rejected in 2006. The lawsuit is in final appeal and attorneys advise that it is virtually certain that Eastern will be awarded $30 million.

Required: Prepare the appropriate journal entries that should be recorded as a result of each of these contingencies. If no journal entry is to be made, state why.

Solution Preview

(a) Debit Bad Debt expense $12,000,000
Credit Allowance for doubtful accounts $12,000,000
To record a provision for bad debt expense for 2006 based on 4% of credit sales.

(b) Debit Warranty expense $6,000,000
Credit Estimated liabilities under warranties $6,000,000
To record estimated warranties ...

Solution Summary

The solution discloses the general entry for each problem together with an explanation of why or why not an entry is required.