Question

Ultrasonic Sound Wave Ltd. 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—2% of sales; second year after sale—3% of sales; and third year after sale—4% of sales. Sales and actual warranty expenditures for the first three years of business were:

Year	Sales	Warranty Expenditures
2015	$810,000	$6,500
2016	1,070,000	17,200
2017	1,036,000	62,000

Required:

1. Calculate the amount that Ultrasonic Sound Wave Ltd. should report as warranty expense on its 2017 income statement and as a warranty liability on its December 31, 2017 statement of financial position 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.   

2. Assume that Ultrasonic Sound Wave warranty expenditures in the first year after sale end up being 4% of sales, which is twice as much as was forecast. How would management account for this change?

Answer 1

1.  warranty liability in 2015

-- First year = Sales*2% = $ 810000 *.02 = 16200 warranty liabilities in balance sheet

First year Actual warranty expenditure = 6500 to be deducted from warranty liabilities

-- Second year = Sales* 3 % = 1070000 *.30 = 32100 warranty liabilities

Second year = actual expenditure = $ 17200

closing balance of warranty liabilities in balance sheet( DEC 31 2016)

warranty balance (16200-6500) $ 9700

Add: warranty liabilities in 2nd year $ 32100

less: second year expenditure $ 17200

Closing balance of warrant liabilities $ 24600

-- third year warranty liabities = 1036000*.04 = $ 41440

Actual expenditure = $ 62000

warranty laibilities as on 31 dec 2017

warranty liab opening = $ 24600

add: warranty liab in 2017 = $ 41440

less:actual expenses = $ 62000

warranty liability balance as on dec 31 dec 2017 = 4040

-- in income statement of 2017 of ultrasonic sound wave ltd

warrenty expenses shown = 41440

Journal entry

-- warranty exp Dr 41440

To warrant Liab. 41440

4% of 2017 sales

2. if in first year warranty 4% instead of 2% how managment change account:(assume 2 and 3 year same)

warranty liability in 2015

-- First year = Sales*4% = $ 810000 *.04 = 32400 warranty liabilities in balance sheet

First year Actual warranty expenditure = 6500 to be deducted from warranty liabilities

-- Second year = Sales* 3 % = 1070000 *.30 = 32100 warranty liabilities

Second year = actual expenditure = $ 17200

closing balance of warranty liabilities in balance sheet( DEC 31 2016)

warranty balance (32400-6500) $ 25900

Add: warranty liabilities in 2nd year $ 32100

less: second year expenditure $ 17200

Closing balance of warrant liabilities $ 40800

-- third year warranty liabities = 1036000*.04 = $ 41440

Actual expenditure = $ 62000

warranty laibilities as on 31 dec 2017

warranty liab opening = $ 40800

add: warranty liab in 2017 = $ 41440

less:actual expenses = $ 62000

warranty liability balance as on dec 31 dec 2017 = 20240

-- in income statement of 2017 of ultrasonic sound wave ltd

warrenty expenses shown = 41440

Journal entry

-- warranty exp Dr 41440

To warrant Liab. 41440

4% of 2017 sales