Question

Whispering Winds Corporation manufactures a line of amplifiers that carry a three-year warranty against defects. Based on experience, the estimated warranty costs related to dollar sales are as follows: first year after sale—1% of sales; second year after sale—2% of sales; and third year after sale—3% of sales. Sales and actual warranty expenditures for the first three years of business were:

		Sales			Warranty Expenditures
2018		$800,000				$16,400
2019		1,110,000				47,000
2020		1,037,000				85,000

(a)

Calculate the amount that Whispering Winds Ltd. should report as warranty expense on its 2020 income statement and as a warranty liability on its December 31, 2020 SFP using the assurance-type warranty (expense-based approach). Assume that all sales are made evenly throughout each year and that warranty expenditures are also evenly spaced according to the rates above.

Warranty expense
Warranty liability

Answer 1

An assurance-type warranty guarantees that the product will function as intended. This type of warranty promises to repair or replace a delivered good or service if it does not perform as expected.

Since an assurance-type warranty guarantees the functionality of a product, the warranty is not accounted for as a separate performance obligation, and thus no transaction price is allocated to it. Rather, to account for an assurance-type warranty the vendor should estimate and accrue a warranty liability when the promised good or service is delivered to the customer (ASC 460).

As the estimated warranty expenditures is as first year after sale—1% of sales; second year after sale—2% of sales; and third year after sale—3% of sales and all sales are made evenly throughout each year.

We need to calculate the total estimated warranty expenditures liability on December 31, 20200 as below:

1. No expense liability for sales made in January 2018 since the 3 years warranty period is over by December 31, 2020

2. 1 month expense liability @3% for the sales made in February 2018 since 35 months period of warranty is already over by December 31, 2020 and so on

Hence Winds Ltd. should report $111,078 as warranty expense on its 2020 income statement and as a warranty liability of $26,078 on its December 31, 2020.