Renew Energy Ltd. (REL) manufactures and sells directly to customers a special long-lasting rechargeable battery for use in digital electronic equipment. Each battery sold comes with a guarantee that will replace free of charge any battery that is found to be defective within six months from the end of the month in which the battery was sold. On June 30, 2014, the Estimated Liability Under Battery Warranty account had a balance of $45,000, but by December 31, 2014, this amount had been reduced to $5,000 by charges for batteries returned.
REL has been in business for many years and has consistently experienced an 8% return rate. However, effective October 1, 2014, because of a change in the manufacturing process, the rate increased to 10%. Each battery is stamped with a date at the time of sale so that Bartlett has developed information on the likely pattern of returns during the six-month period, starting with the month following the sale. (Assume no batteries are returned in the month of sale.)
Month % of Total Returns
Following Sale Expected in the Month
1st ....................................... 20%
2nd ...................................... 30%
3rd ...................................... 20%
4th ...................................... 10%
5th ...................................... 10%
6th ...................................... 10%
100%
For example, for January sales, 20% of the returns are expected in February, 30% in March, and so on. Sales of these batteries for the second half of 2014 were:
Month Sales Amount
July ..................... $1,800,000
August ................... 1,650,000
September ............... 2,050,000
October .................. 1,425,000
November ............... 1,000,000
December .................. 900,000
REL's warranty also covers the payment of the freight cost on defective batteries returned and on new batteries sent as replacements. This freight cost is 10% of the sales price of the batteries returned. The manufacturing cost of a battery is roughly 60% of its sales price, and the salvage value of the returned batteries averages 14% of the sales price. Assume that REL follows IFRS and that it uses the expense approach to account for warranties.
Instructions
(a) Calculate the warranty expense that will be reported for the July 1 to December 31, 2014 period.
(b) Calculate the amount of the provision that you would expect in the Estimated Liability Under Battery Warranty account as at December 31, 2014, based on the above likely pattern of returns.