Question

On September 1, 2016, Carolina Electronics Company has 1,000 Blu-ray players ready for sale. On October 1, 2016, 900 are sold, on account, at $125 each with a 1-year assurance-type warranty. Carolina estimates that the warranty cost on each Blu-ray player sold will probably average $10 per unit. During the final 3 months of 2016, Carolina incurred warranty costs of $4,000, and in 2017 warranty costs were $5,000.

Required:

1.	Prepare the journal entries for the preceding transactions.
2.	Show how the preceding items would be reported on the December 31, 2016, balance sheet.
3.	Prepare the journal entries for the preceding transactions using the modified cash basis method.
4.	Next Level Which method produces the better measure of income? Why?

CHART OF ACCOUNTS
Carolina Electronics Company
General Ledger
ASSETS 111 Cash 121 Accounts Receivable 141 Inventory 152 Prepaid Insurance 181 Equipment 189 Accumulated Depreciation LIABILITIES 211 Accounts Payable 231 Salaries Payable 240 Estimated Warranty Liability 250 Unearned Revenue 261 Income Taxes Payable EQUITY 311 Common Stock 331 Retained Earnings	REVENUE 411 Sales Revenue EXPENSES 500 Cost of Goods Sold 511 Insurance Expense 512 Utilities Expense 521 Salaries Expense 532 Bad Debt Expense 540 Interest Expense 541 Depreciation Expense 551 Warranty Expense 559 Miscellaneous Expenses 910 Income Tax Expense

Prepare the necessary journal entries to record:

	1. the sale of Blu-ray players on account on October 1, 2016
	2. the related warranty accrual on October 1, 2016
	3. the warranty costs paid during the last quarter of 2016
	4. the warranty costs paid during the 2017
	Additional Instructions

PAGE 9

GENERAL JOURNAL

	DATE	ACCOUNT TITLE	POST. REF.	DEBIT	CREDIT
1
2
3
4
5
6
7
8

Prepare the necessary journal entries to record the above transactions using the modified cash basis method.

PAGE 9

GENERAL JOURNAL

	DATE	ACCOUNT TITLE	POST. REF.	DEBIT	CREDIT
1
2
3
4
5
6

Show how the items would be reported on the December 31, 2016, balance sheet under U.S. GAAP. Additional Instructions

Carolina Electronics Company

Partial Balance Sheet

December 31, 2016

1	Current Liabilities:
2

Which method produces the better measure of income? Why?

Select the item below that is true in response to the better measure of income and the reason why.

The modified cash basis method provides the better measure of income because it properly matches warranty costs to the revenues that the warranties helped generate. This method also creates a contingent liability representing a company’s expected use of resources.

The accrual method provides the better measure of income because it properly matches warranty costs to the revenues that the warranties helped generate. This method also creates a contingent liability representing a company’s expected use of resources.

The direct expense method provides the better measure of income because it expenses warranty costs when incurred.

Under the accrual method, a company’s liabilities will be misstated. In addition, the accrual method misstates warranty expense, and income, because the actual warranty repair occurs in a period other than the period in which the sale occurs.

Answer 1

1.

Date	Account Titles and Explanation	Debit	Credit
Oct 1, 2016	Cash (900*125)	$112,500
	Sales		$112,500
Dec 31, 2016	Warratny expense (900*10)	$9,000
	Estimated warranty liability		$9,000
Dec 31, 2016	Estimated warranty liability	$4,000
	Cash		$4,000
Dec 31, 2017	Estimated warranty liability	$5,000
	Cash		$5,000

2.

Carolina Electronics Company
Partial Balance Sheet
December 31, 2016
Current assets
Cash on hand	$108,500
Current liability
Estimated warranty liability	$5,000

3.

Date	Account Titles and Explanation	Debit	Credit
Oct 1, 2016	Cash (900*125)	$112,500
	Sales		$112,500
	(To record cash received from sale)

4. Taking both methods under consideration it can be said modified cash basis produce the better measures of income because the warranty liability is not recorded in this method as the warranty has not occur in current year and will take place in future.

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