Question

For the financial year ending 30 June 2020, Malkin Ltd has some liability issues for which it seeks your help:

1. The company sells widgets and provides a one-year warranty. 100,000 widgets were sold for the year ended 30 June 2020, and 150,000 are expected to be sold next year. 2% of units sold are estimated to require warranty work, at an average cost of $3 per unit. Actual repairs incurred for units sold in the year just ended were $1,800. In the unadjusted trial balance, the Warranty Provision account has a $1,200 debit balance.
   1. Prepare the AJE required to update the Warranty Provision.
   2. What balance should be shown for Warranty Provision on the 30 June 2020 Balance Sheet?
2. Employees are paid $2,980 cash in hand every two weeks (wages and salaries), representing 10 days of work. At the same time, $1,200 of PAYE is withheld by Malkin Ltd, which it will pay to the IRD on the employees’ behalf. 30 June was on a Tuesday, and the last payroll run was the previous Friday (26 June). Employees do not work weekends. Prepare the AJE required on 30 June.
3. Malkin Ltd’s management is having trouble distinguishing provisions, contingent liabilities, and liabilities such as accounts or notes payable. Explain to Malkin Ltd’s management the key differences between these three categories, including their reporting implications, e.g., recognition or not; if not, what then?

Answer 1

a)

(i)Journal Entry

June-30	Warranty Expense A/c (100000*2%*$3)	6000
	To Warranty Provision A/c		6000
(Being Liability recorded)

June-30	Warranty Provision A/c	1800
	To Cash A/c		1800

ii) Balance of Warranty Provision

=Opening Warranty Balance+Provision Created-Actual amount expensed

=1200+6000-1800

=$5400

b) Adjusted Journal Entry required on June 30

Amount to be paid to employee for 2 days= (2980/10 days)* 2days=$596

PAYE To be withheld= (1200/2980)*596=$240

Date	Particular	Debit	Credit
Jun-30	Salaries & Wages Expense	596
	To PAYE Tax Payable		240
	To Net Payroll Payable		356
(Being Amt to be payable to employees recorded)

c)Difference between provision, contingent liabilities and liabilities

Liabilities- It is something that person owes to some other person. Amount to be paid is mostly certain. For example accounts payable, loan Payable.It is present obligation of the entity arising from past events.

Accounting Treatment

It is recognised in the books of accounts as and when it is payable.

Provision-Provision refers to liability of uncertain timing or amount. It means in case of provision either the amount to be paid is uncertain or the time when it is to be paid is uncertain.

Accounting Treatment

Following the principle of prudence it is recorded in the books of account on the basis of estimates made by the accountant.

Contingent Liabilities- A contingent Liabilities is a possible obligation that arise from past event and whose existence will be confirmed on the occurance or non occurance of one or more uncertain future events which are not within the control of the entity. A contingent liability includes provision.

Accounting Treatment

A contingent liability should not be recognised in the books of account.It should be disclosed in the notes to account.