When a provision for product warranties is recognized before any warranty claim is paid, what is the immediate effect?
Correct answer: A. Profit decreases and a liability increases
- A. Profit decreases and a liability increases
- B. Profit increases and a liability decreases
- C. Cash decreases and profit increases
- D. Assets increase and liabilities decrease
Explanation
The estimated warranty cost is charged to the period in which the related sales occur, reducing profit. The unpaid estimated obligation is recorded as a liability, although no cash payment occurs at recognition.
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About Accruals, Prepayments and Provisions
Accruals and prepayments adjust income and expenses to the accounting period in which they are earned or incurred, following the matching principle. Provisions recognise expected obligations or losses when their amount or timing is uncertain, which distinguishes them from ordinary accruals and from general reserves.
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