Breton Inc. manufactures industrial lighting fixtures with two main product lines: interior and exterior fixtures. The fixtures are sold with a one-year warranty on parts and labor. During 20X0, Breton’s engineering group undertook a five-year review of its warranty claims history and costs, and established that an appropriate accounting policy for warranty costs is to accrue 3% of annual sales for exterior fixtures and 2% of annual sales for interior fixtures. PA, Breton’s auditor, has used this analysis as the basis for evaluating provision for estimated warranty cost at year-end for the past two year’s audits. During 20X3, Breton’s competition increased as light fixtures from China entered the market, selling for prices 40 to 50% lower. To maintain its customer base, Breton’s senior management decided to promote the higher quality of Breton’s products, and expanded Breton warranty coverage to two years to support these quality claims. However, to keep costs in line, there were no changes to materials used or production methods. PA is now assessing the 20X3 year-end provision for estimated warranty costs and learns that there is no plan to change the approach for developing the estimate. Breton sales people receive commissions of 1% of gross sales. Senior managers, including the CFO, receive bonuses only if the company’s pre-tax profit exceeds $300,000.

Required:
a. Discuss the implications of the changes in Breton’s competitive environment and business strategy for the audit of its warranty liability estimate. Do you think it is fairly presented?
b. If you were the CFO, what arguments would you make to support not changing the method used to estimate warranty liability for the current year?
c. What actions do you recommend PA take in this case?