Due to contingent liabilities, many companies report different amounts of income on their income statement than on their income tax return, which leads to deferred income tax balances. A company is required to accrue a contingent liability if it is probable that the liability has been incurred and the amount can be estimated. This case study focuses on accounting implications of the most common contingencies—warranties and lawsuits—at Maytag Corporation, a leading manufacturer of home and commercial appliances.
Under the accrual accounting method, estimated warranty costs are charged to operating expenses in the year of sales, and a corresponding liability is established. This liability is reduced when the actual warranty charges are incurred. The notes on the financial statements reveal that in 2004 Maytag estimated $132,841 in warranty liability and made $121,162 in warranty payments. Therefore, the warranty reserve at the end of fiscal 2004 totaled to $114,905 (Exhibit 1). In addition, there was another contingency Maytag had to record in 2004 due to a front-load washer litigation settlement. The Income Statement reveals that the amount was reasonably predicted to be $33,500 (Exhibit 2). However, the Consolidated Statement of Cash Flows shows a non-cash item in the amount of $23,092 added back in the operating activities section labeled “Front-load washer litigation, net of cash paid.” This amount represents the outstanding litigation accrual.
By adding the outstanding litigation accrual to the warranty reserve, the contingent liabilities at the end of fiscal 2004 total $137,997. This amount was deducted from the fiscal 2004 income but could not be deducted on the income tax return until paid. At a tax rate of 36%, the difference between the income tax expenses calculated on income before taxes on the income statement and the taxes due based on taxable income per the income tax return would be $49,678. This temporary difference led to the deferred tax assets

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