Question

Carnes Electronics sells consumer electronics that carry a 90-day manufacturer’s warranty. At the time of purchase, customers are offered the opportunity to also buy a two-year extended warranty for an additional charge. During the year, Carnes received $426,000 for these extended warranties (approximately evenly throughout the year).

Required:
1-a. Does this situation represent a loss contingency?
1.b. How should it be accounted for?
2. Prepare journal entries that summarize sales of the extended warranties and any aspects of the warranty that should be recorded during the year.

Answer 1

Contingent loss:

The existing situation where is the possibility of incurring a loss on the happening or non happening of a future event is known as loss contingency. The loss contingency should be accounted for in the books of accounts depending on the likelihood of the event. Likelihood may be probable, or reasonably possible, or remote.

1) This is not a contingency loss. An extended warranty of a product is sold separately from the warranted product and therefore it is constitutes a separate sales transaction. Hence revenue should be recognized over the same period, as the earning process for an extended warranty continues during the contract period. Revenue from sale of extended warranty contracts are deferred as a liability at the time of sale, and it is recognized on a straight-line basis over the contract period.

2)

Explanation:

The extended warranties are sold to the customers assuming on account then the accounts receivable punt is debited by crediting unearned revenue account for the received for two years extended warranties. Unearned revenue account is credited because the amount received for warranties it may be earned or may not be during the period of warranty.

Explanation:
At the end of the year, if no warranty electronics are received back with complaints for repairs then the unearned revenue account credited for in the books at the time of sale of extended warranty should be cancelled by debiting it and crediting revenue from extended warranty асcount for the revenue earn During current period.