Question

Cherry Wood Corporation sells blenders under a three-year warranty contract that requires it to replace defective parts and provide necessary repair and labour. During 2019, the corporation sold 1,000 blenders for cash at a unit price of $800 each. Similar three-year warranty agreements are available separately and are estimated to have a stand-alone value of $120. On the basis of past experience, the per-unit, three-year warranty costs are estimated to be $20 for parts and $30 for labour. For simplicity, assume that all sales occurred on December 31, 2019 rather than evenly throughout the year and any warranty revenue (if applicable) is earned evenly over the three-year period. In 2020, the actual warranty costs to Cherry Wood are $5,000 for parts and $10,000 for labour.

Instructions:

1 Assurance Method:

1. a) Assume the company uses the assurance method and record any necessary journal

   entries in 2019 and 2020 applying the expense approach.

2. b) What liability relative to these transactions would appear on the December 31, 2019

   statement of financial position and how would it be classified.

2. Service Type Method:

1. a) Assume the company uses the service-type method and record any necessary

   journal entries in 2019 and 2020 applying the revenue approach.

2. b) What liability relative to these transactions would appear on the December 31, 2019

   statement of financial position and how would it be classified.

Answer 1

1. Assurance method:

a.

Year	General Journal	Debit	Credit
		$	$
2019	Cash	800,000
	Warranty Expense	50,000
	Warranty Liability		50,000
	Sales Revenue		800,000
	To record sales and to accrue warranty liability
2020	Warranty Liability	15,000
	Inventory		5,000
	Accrued Wages		10,000
	To record warranty costs incurred

b. As of December 31, 2020, warranty liability of $ 50,000 would be carried in the statement of financial position, in the liabilities section, under the head current liabilities.

2. Service Type Method:

a.

Year	Account Titles	Debit	Credit
		$	$
2019	Cash	920,000
	Warranty Expense	50,000
	Warranty Liability		50,000
	Unearned Warranty Revenue		120,000
	Sales Revenue		800,000
	To record sales revenue and related warranties
2020	Unearned Warranty Revenue	40,000
	Warranty Revenue		40,000
	To recognize revenue on service type warranty
2020	Warranty Liability	15,000
	Inventory		5,000
	Accrued Wages		10,000
	To record warranty costs

b. On December 31, 2019, the current liabilities section of the statement of financial position would carry

i. Warranty liability : $ 50,000

ii. Unearned warranty revenue: $ 120,000