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Warranties, Accrual, and Cash Basis

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Pijols co sells a machine for $7,400 under a 12-month warranty agreement that requires the company to replace all defective parts to provide the repair labor at no cost to the customers. With sales being made evenly throughout the year, the company sells 650 machines in 2008 (the warranty expense is incurred half in 2008 and half in 2009). As a result of product testing, the company estimates that the warranty cost is $370 per machine ($170 parts and $200 labor).

Instructions:

A) Under application of the expense warranty accrual method for:
1. Sale of machinery in 2008
2. Warranty costs incurred in 2008
3. Warranty expense charged against 2008 revenues
4. Warranty costs incurred in 2009

B) Under application of the cash basis method for:
1. Sale of machinery in 2008
2. Warranty costs incurred in 2008
3. Warranty expense charged against 2008 revenues
4. Warranty costs incurred in 2009.

C) What amount, if any, is disclosed in the balance sheet as a liability for future warranty costs as of December 31, 2008, under each method?

D) Which method best reflects the income in 2008 and 2009 at A. Pujols co? why?

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Solution Summary

This tutorial provides instructions on how to use the accrual method and cash basis method to determine future warranty costs.

Solution Preview

A) 1. Sale of machinery - $4,810,000 ($7,400*650 machines)

2. Warranty expense incurred in 2008 -
Total warranty expense $240,500 ($370*650)
Warranty expense incurred in 2008 - half of $240,500 = $120,250

3. Warranty expense charged to revenue in 2008 -
Total warranty expense $240,500 ($370*650)

4. Warranty expense incurred in 2009 -
Total warranty ...

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