Question

Problem Three:

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

Answer:

A) Sales for the year ended 30 June 2020 are 100,000 x 3

= $300,000

Estimated warraanty provision @ 2% of sales = $300,000 x 2/100

= 6,000

The adjusting journal entry passed for warranty liability would be :

Date	Particulars	Debit	Credit
30-Jan-20	Warranty Expenses A/c	$ 1,200
	To Warranty Provision A/c		$ 1,200
	(To record warranty expenses for the current year incurred in excess of warranty provision)
30-Jan-20	Warranty Expenses A/c	$ 6,000
	To Warranty Provision A/c		$ 6,000
	(To record warranty provision for the current year sales @ 2%)

Note: Warranty Provision A/C shows a debit balance of $1200 which means that the warranty expenses during the year were $1200 more than the provision available. Warranty Provision A/C is a liability account and ordinarily it has a credit balance and should not show a debit balance. Hence, this debit balance should also be provided for first before making a provision or otherwise only a provision of $4800 (6000 credit - 1200 debit) would only be available for the next year.

B) Adjusting Journal Entry for salary payable will be for 5 days since there are 5 days from 26th June (last payday) to June 30.

The amount of the journal entry for total salary will be

= (2980+1200)

= 2090

which will be further broken into 2980/2 = 1490 for cash portion and 1200/2 = 600 for PAYE withheld portion. Adjusting Journal entry for salary

Date	Particulars	Debit	Credit
30-Jun-20	Salary Expenses A/c	$ 2,090
	To Salary Payable A/c		$ 1,490
	To Payee Tax Withheld A/c		$    600

C) Diffence between provisions, contingent liabilities and liabilites:

A provision is an amount set aside to cover a specific or probable future expense such as provision for income tax or for reduction in the value of an asset such as provision for bad debts. In financial reporting, provisions are required to be recognized as liabilities and recorded on the balance sheet as a current liability and also matched to the relevant expense account on the income statement.

contingent liabilities are those liabilities which have not yet materialized but can materialize in future depending on the outcome of a specific event. These liabilities show the possibility of a loss which may occur in the future. The company would show all contingent liability as a footnote to its balance sheet. Their recognition on the balance sheet depends upon the degree of the possibility of their happening and the estimatibility of the loss they can cause. For example, if a lawsuit has not yet been decided ahainst the company but if the outcome of the lawsuit and amount of damages payable can be assessed with a reasonable degree of certainty, the company must provide for such contingent liability even though the event has not actually happened.   

Liabilities are the concrete financial obligations of a company, such as the money owed by a business to its suppliers (such as accounts and notes payable), bonds payable, loans owed to bank or other parties, wages payable to employees, expenses accrued but not yet paid etc. All liabilities must be reported on the balance sheet of a business.

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