Question

Derby Inc. is a manufacturer and retailer of bicycles. The company offers a 2 year standard (assurance type) warranty with all bikes sold to cover normal manufacturing defects. In the first quarter of 2020, Derby sold a total of 250 bikes at a retail price of $400 each. Each bike costs on average $225 to produce and, historically, the costs associated with the warranty average $75 per bike. The company accepts cash and debit cards as payment for the bikes. a) Prepare all journal entries related to the sale of the 250 bikes that occurred in the first quarter of 2020. b) In the second quarter, Derek brings in his bike for some repairs due to faulty steering. Derby paid $100 of labour and $30 for parts to repair Derek’s bike. These costs were covered by the basic warranty. Prepare the journal entry to account for the repairs made to Derek’s bike. c) The repairs on Derek’s bike totalled $130 while the estimated average cost of the warranty was $75. Do you think that Derby made an error in estimating the warranty cost? Explain and support your answer. d) At the end of the second quarter, because of adverse economic conditions associated with a global pandemic, the expected selling price per bike has fallen to $230. The cost to sell each bike averages $20 per bike. There are 100 bikes in inventory at the end of the second quarter. What impact, if any, does this information have on the financial statements at the end of the second quarter? Explain and support your

Answer 1

Derby sold a total of 250 bikes at a retail price of $400 each and bikes are covered under warranty for 2 years.

The expected average warranty cost per bike is $75 , which is booked at the time of sale only.

1. The journal entry for Quarter -1

Date	Account Titles and Explanations	Debit ($)	Credit ($)
Qtr-1	Cash / Bank Account ---------Dr	100000
	To Bike sales account		100000
	(Sales of 250 bikes @400)
Qtr-1	Warranty Expenses----------Dr	18750
	To Warranty expenses Liability account		18750
	(Warranty expenses for 250 bikes @75).

2. The bikes are covered under the warranty hence the warranty claims of Derek's need to be paid by the Derby Inc.

Accordingly the journal entry will be as follows as the provision has already been made for it :

Date	Account Titles and Explanations	Debit ($)	Credit ($)
Qtr-2	Warranty expenses liability account---Dr	130
	To Cash Account		130
	(Warranty claim paid of Derek's bike)

3. The Derby has paid $ 130 for the warranty claim of Derek's bike even though the provisions had been made up of $75 per bike. The provision of $75 is the average provision cost of bikes which have been sold during the Qurter-1 the estimates are made after due consideration to the probability of damages and claims of the buyer. The management estimates the cost to be provided for warranty based on its past experiences and product quality.

In certain circumstances the estimates may not be accurate but they work as basis of entire population not ony a basis of one warranty cliam.With regards to Derek's claim of $130 being more than the provision will not make it an error in estimation of warranty cost.

4.  At the end of the second quarter, because of adverse economic conditions associated with a global pandemic, the expected selling price per bike has fallen to $230 and the cost to sell each bike averages $20 per bike.

The Manufacturing cost per bike is = $225 and additional cost to sales of $20 makes the total cost = $245

There are 100 bikes in inventory at the end of the second quarter. which are estimated to sell at $230 the Derby Inc will suffer a loss of $25 per bike sold and if we take the warranty cost in consideration then the loss per bike will rise to $100 (25$+75$).

In such situtaion selling should be avoided as it will not cover the cost even it will be a big loss for Derby Inc.