Question

The treasurer of Landowska Co. has that conservatism is a doctrine that is followed in accounting and, therefore, proposes that several policies be followed that are conservative in nature. State your opinion with respect to each of the policies listed.

1. The company gives a 2-year warranty to its customers on all products sold. The estimated warranty costs incurred from this year’s sales should be entered as an expense this year instead of an expense in the period in the future when the warranty is made good.
2. When sales are made on account, there is always uncertainty about whether the accounts are collectible. Therefore, the treasurer recommends recording the sale when the cash is received from the customers.
3. A personal liability lawsuit is pending against the company. The treasurer believes there is an even chance that the company will lose the suit and have to pay damages of \(200,000 to \)300,000. The treasurer recommends that a loss be recorded and a liability created in the amount of $300,000.

Short answer

1. It is acceptable if a fairly definite evaluation is possible.
2. It is not acceptable. Most accounts are overdue, or the firm will exit the business instantly.
3. It is not acceptable as the provision for the probable loss can be created by allocation of retained earnings until judgment has been provided on the case or it is settled; entry of the loss normally shows prediction.

Step-by-step solution

Meaning of Conservatism

It is a principle or a justification of accounting information requiring accountants to make the books of accounts, i.e., financial statements, cautiously and verifies accounting entries correctly.

Explanation for statement ‘a’

It is justifiable. Suppose a probably right evaluation is viable. To ensure that the warranty costs are evaluated correctly, they should match against the linked sales revenue.

Explanation for statement ‘b’

It is not justifiable. Accounts are mostly overdue, or the firm will exit the business soon. Therefore, sales can be listed when created. Moreover, other firms list sales when created or collected; therefore, if accounts for Landowska Co. are to be matched with other firms, they must be kept on a comparable basis. However, evaluation for uncollectible accounts should be listed if there is a possible basis for evaluating bad debts.

Explanation for statement ‘c’

It is not justifiable. A business entity can create a provision for the probable loss through allotment of retained earnings.Still, until judgment has been provided on a case or settled, the loss's entry normally shows prediction. Listing it before the final judgment is a possibly inappropriate legal method. For the loss to be identified at this point, the loss would have to be possible and considerately admirable. It is noted that disclosure is needed in the footnotes of the balance sheet if the loss is not listed; however, conservatism is not a portion of the conceptual framework.