CA13-6. (Warranties and Loss Contingencies)

The following two independent situations involve loss contingencies.

Part 1:Benson Company sells two products, Grey and Yellow. Each carries a 1-year warranty.

• 1.Product GreyProduct warranty costs, based on past experience, will normally be 1% of sales.
• 2.Product YellowProduct warranty costs cannot be reasonably estimated because this is a new product line. However, the chief engineer believes that product warranty costs are likely to be incurred.

Instructions

How should Benson report the estimated product warranty costs for each of the two types of merchandise above? Discuss the rationale for your answer. Do not discuss disclosures that should be made in Benson's financial statements or notes.

Part 2:Constantine Company is being sued for $4,000,000 for an injury caused to a child as a result of alleged negligence while the child was visiting the Constantine Company plant in March 2017. The suit was filed in July 2017. Constantine's lawyer states that it is probable that Constantine will lose the suit and be found liable for a judgment costing anywhere from $400,000 to $2,000,000. However, the lawyer states that the most probable judgment is $1,000,000.

Instructions

How should Constantine report the suit in its 2017 financial statements? Discuss the rationale for your answer. Include in your answer disclosures, if any, that should be made in Constantine's financial statements or notes.