[Peachey]

A new product introduced by Wilkerson Promotions carries a two-year warranty against defects. The estimated warranty costs related to dollar sales:

Year of Sale... 3%------Year after Sale... 5%
Sales and actual warranty expenditures for the year's ended Dec 31, 2007 & 2008
... Sales... Actual Warranty Expenditures
2007... 800,000... 20,000
2008... 1,000,000... 70,000

What amount should Wilkerson report as its estimated liability as od Dec 31, 2008.

This is my working I know I've done something wrong but I can't tell what it is: Please help.

Dec 31, 2007... Product Warranty Expense... 24,000
... product warranty Payable... 24,000 (800,000 * 3%)

Dec 31, 2007... Product Warranty Payable... 20,000
... Supplies... 20,000

Dec 31, 2008... Product Warranty expense... 66,000
... Product Warranty Payable... 66,000
(1,000,000 * 3% = 30,000) (800,00 * 5% = 40,000)
30,000 + 40,000 - (24,000 - 20,000)

Product Warranty Payable... 70,000
... Supplies... 70,000

[rehmanvohra]

Before an answer can be given, can you please clarify on the following:
1. What are the terms of warranty - to replace the goods supplied or correcting defects
2. The details of actual expenditure incurred in 2007 and 2008
3. The break up of expenditure of 70,000 in 2008, how much of it relates to 2007 sales

[Peachey]

This is the way the question were asked there are no more details.

[morgaine300]

Renmanvohra, you're getting too complicated again. :-) She took it out of supplies so I'm assuming that's the way they did it in the examples in the book...

Peachy - everything's fine except for the adjusting entry at the end of 08. You've got the adjustment amount: 800,000*5% + 1,000,000*3%. But you subtracted out the balance from the liability account from 2007. You can't journalize a balance. That's just what is in the account before you make the entry, but it doesn't affect the entry.

The amount for 08 is 70,000 - that's the expense, and the amount added to the liability. Which gives it a 74,000 balance prior to making the entry for the actual expenditure.

Make sense?

[Peachey]

Is this it:
12/31/08 Product warranty Expence... 70,000

[Peachey]

Is this it:
12/31/08-Product Warranty Expense.. 70,000
... Product Warranty Payable.. 70,000
1,000,000 * 3% = 30,000
800,000 * 5% = 40,000

Product Warranty Payable... 74,000
... Supplies... 74,000
How did you get 74,000 .The calculation please. and thank you.

[rehmanvohra]

renmanvohra, you're getting too complicated again. :-) She took it out of supplies so I'm assuming that's the way they did it in the examples in the book...

Peachy - everything's fine except for the adjusting entry at the end of 08. You've got the adjustment amount: 800,000*5% + 1,000,000*3%. But you subtracted out the balance from the liability account from 2007. You can't journalize a balance. That's just what is in the account before you make the entry, but it doesn't affect the entry.

The amount for 08 is 70,000 - that's the expense, and the amount added to the liability. Which gives it a 74,000 balance prior to making the entry for the actual expenditure.

Make sense?

I am sorry, morgaine 300, I am afraid I do not agree with you. The warranty period is two years. After the expiry of the two year period, there can be no liability that can be carried forward. It is for this reason that the break up of 2008 expenses was requested. I hope you will agree to the reason.

[Peachey]

Now I am more confused than ever :confused:

[rehmanvohra]

Now i am more confused than ever :confused:

I am sorry, Peachy. I do not blame you at all. I will try and explain as far as possible.

As you know when a business issues warranties, they either replace the goods or correct the defect in the product. This aspect is not clear in your question and that is why I mentioned the three points. Your questions states that the company incurred costs of $20,000 in 2007 and $70,000 in 2008. From your question, I assume that the expenditure incurred is replacement of good - that is fine.

The company estimates that a total of 8% (3% + 5%) will be incurred. That is fine too since the actual claims may well exceed. But in no case the claims will be entertained after the expiry of two years. It is for this reason that I asked for the break up of expenses in 2008.

Personally, I would have expensed the full 8% in each of the years. The liability meets the recognition and measurement criteria as prescribed by the FASB. My entries would be:

2007
Warranty expenses $64,000
Warranty payable $64,000

Warranty payable 20,000
Cash/supplies 20,000

2008
Warranty expenses $80,000
Warranty payable $80,000

Warranty payable 70,000
Cash/supplies 70,000

At 31 December 2008, the balance sheet will report a liability of $54,000.

I hope I have been helpful. You may ask why did I recognize the full amount in each year. This is because the sales were made in that year and on that a total of warranty claims are payable. The company is committed to honor its obligations of fulfilling the claims. Of course, over the period, the company may improve on its quality control and reduce the warranty claims in the future.

[Peachey]

Thank you a lot, but what is the calculation to get the liability 54,000, I am really trying to understand.

[morgaine300]

My apologies - I have to concede to rehmanvohra. One of those cases where I should have done the problem myself first without looking at the answers the student gave -- when I look at the answers first I have a tendency to just sort of "go with the flow" of what the person's doing and let it influence my thinking. :-) (Bad habit I have.)

Yes, the entire expense needs to be in the year of the sales, due to the matching concept.

I ignored the two-year thing. The only thing that would have hit that limitation is something sold right on Jan 1 of 07.

Peachy, the 54,000 is just coming from all the numbers put into and out of the payables account. Look at the entries: 64,000 and 80,000 were put in, and 20,000 and 70,000 were taken out. What's that leave you with? If you want to know what a balance in an account is, simply post your entries to t accounts and balance them.

[Peachey]

Thank you all a lot, I am going to school on-line