You are working as the head accountant of AB Electronics and are finalizing the Financial statements for
Question:
You are working as the head accountant of AB Electronics and are finalizing the Financial statements for the year ended 30th June. Your subordinate has come to you with a couple of tricky events that occurred a week before his meeting with you and he is not sure about the accounting treatment required to record those events. The following are the details of those events:
A customer has filed a court case against your company and the next hearing in the court is a couple of months away, he is not sure about the outcome of the court case and his assessment states that there is a 50% chance of your company losing the case. If you lose the case, you could end up paying anything between $10000 to $100000 to that customer in damages.
You have sold a custom-made product (covered by 2 years warranty) for another valuable customer a couple of weeks back and your quality assurance department has reported a flaw with the product which will definitely require repairs costing your business anywhere between $700-$900 in 3 month time. You are 100% certain that the product will come for repair within the next 3 months.
Advice your subordinate as to whether those events be recorded in the books of account or not and how the above two events are treated in the books of account, if those need to be recorded, duly giving reasons for your decision. Also mention the Financial statement in which the above events will be recorded, if those need to be recorded.
Fundamentals of Corporate Finance
ISBN: 978-1259024962
6th Canadian edition
Authors: Richard Brealey, Stewart Myers, Alan Marcus, Devashis Mitra, Elizabeth Maynes, William Lim