Ex. 1—Notes payable.

On August 31, Jenks Co. partially refunded $180,000 of its outstanding 10% note payable made
one year ago to Arma State Bank by paying $180,000 plus $18,000 interest, having obtained
the $198,000 by using $52,400 cash and signing a new one-year $160,000 note discounted at
9% by the bank.

Instructions
(1) Make the entry to record the partial refunding. Assume Jenks Co. makes reversing entries
when appropriate.
(2) Prepare the adjusting entry at December 31, assuming straight-line amortization of the
discount.

Solution 1
(1) Notes Payable [$180,000 + ($160,000 × .09)] .......................... 194,400
Interest Expense ...................................................................... 18,000
Notes Payable .............................................................. 160,000
Cash ............................................................................. 52,400

(2) Interest Expense [(1/3 × ($160,000 × .09)] ............................... 4,800

Notes Payable .............................................................. 4,800

Ex. 2—Provisions
The following situations relate to Washburn Company.
1. Washburn provides a warranty with all its products it sells. It estimates that it will sell
1,200,000 units of its product for the year ended December 31, 2015, and that its total
revenue for the product will be $100,000,000. It also estimates that 60% of the product will
have no defects, 30% will have major defects, and 10% will have minor defects. The cost of
a minor defect is estimated to be $5 for each product repaired, and the cost for a major
defect cost is $15. The company also estimates that the minimum amount of warranty
expense will be $2,500,000 and the maximum will be $12,000,000.
2. Washburn is involved in a tax dispute with the tax authorities. The most likely outcome of
this dispute is that Washburn will lose and have to pay $500,000. The minimum it will lose is
$25,000 and the maximum is $3,000,000.
3. Washburn has a policy of refunding purchases to dissatisfied customers, even though it is
under no obligation to do so. However, it has created a valid expectation with its customers
to continue this practice. These refunds can range from 5% of sales to 9% of sales, with any
amount in between a reasonable possibility. In 2015, Washburn has $50,000,000 of sales
subject to possible refund.

Instructions
Prepare the journal entry to record provisions, if any, for Washburn at December 31, 2015.

Solution 2
(1) Warranty Expense* ............................................................... 6,000,000
Warranty Liability .......................................................... 6,000,000
*Expected warranty costs
% Units Cost per Total Costs
Unit
No defects 60% 720,000 $ 0 $ 0
Major defects 30% 360,000 15 5,400,000
Minor defects 10% 120,000 5 600,000
Total 100% 1,200,000 6,000,000

(2) Tax Expense ......................................................................... 500,000

Taxes Payable .............................................................. 500,000
(3) Sales Returns* ...................................................................... 3,500,000
Allowance for Sales Returns ......................................... 3,500,000

*$50,000,000 × (5% + 9%)/2

Ex. 3—Contingent liabilities.

Below are three independent situations.
1. In August, 2015 a worker was injured in the factory in an accident partially the result of his
own negligence. The worker has sued Wesley Co. for $800,000. Counsel believes it is
possible but not probable that the outcome of the suit will be unfavorable and that the
settlement would cost the company from $250,000 to $500,000.

2. A suit for breach of contract seeking damages of $2,400,000 was filed by an author against
Greer Co. on October 4, 2015. Greer's legal counsel believes that an unfavorable outcome
is probable. A reasonable estimate of the award to the plaintiff is between $600,000 and
$1,800,000. No amount within this range is a better estimate of potential damages than any
other amount.

3. Quinn is involved in a pending court case. Quinn’s lawyers believe it is probable that Quinn
will be awarded damages of $1,000,000.

Instructions
Discuss the proper accounting treatment, including any required disclosures, for each situation.
Give the rationale for your answers.

Solution 3
1. Wesley Co. should disclose in the notes to the financial statements the existence of a
possible contingent liability related to the lawsuit. The note should indicate the range of the
possible loss. The contingent liability should not be accrued because the loss is possible,
not probable.

2. The probable award should be accrued by a charge to an estimated loss and a credit to an
estimated liability of $1,200,000. Greer Co. should disclose the following in the notes to the
financial statements: the amount of the suit, the nature of the contingency, the reason for
the accrual, and the range of the possible loss.
 The accrual is made because it is probable that a liability has been incurred and a
reasonable estimate can be made of the obligation amount. The midpoint amount in the
range of possible losses is used when no amount is a better estimate than any other
amount.

3. Quinn should not record the contingent asset unless it is virtually certain. Usually,
contingent assets are neither accrued nor disclosed. The $1,000,000 contingent asset
should be disclosed because its outcome is considered probable.