Question

Consultants notified management of Goo Goo Baby Products that a crib toy poses a potential health hazard. Counsel indicated that a product recall is probable and is estimated to cost the company $5.5 million. How will this affect the company's income statement and balance sheet this period?

* Please explain clearly. Thank you!

Answer 1

Income statement - decrease net income - $5.5 million

Balance sheet - increase liabilities - $5.5 million

This is a loss contingency and should be accrued because it is both probable that the confirming event will occur and the amount can be at least reasonably estimated. Goo Goo should report a $5.5 million loss in its income statement and a $5.5 million liability in its balance sheet.

Journal entry

Loss - product recall. Dr. $5,500,000

To Liability - Product recall. $5,500,000

A disclosure note is also appropriate.

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