Selzer Equipment Limited sold 500 Rollomatics on account during 2011 at $6,000 each. During 2011, Selzer spent $30,000 servicing the two-year warranties that are included in each sale of the Rollomatic. All servicing transactions were paid in cash.
(a) Prepare the 2011 entries for Selzer using the expense approach for warranties. Assume that Selzer estimates that the total cost of servicing the warranties will be $120,000 for two years.
(b) Prepare the 2011 entries for Selzer assuming that the warranties are not an integral part of the sale, but rather a sep arate service that is considered to be bundled with the selling price. Assume that of the sales total, $160,000 is identified as relating specifically to sales of warranty contracts. Selzer estimates the total cost of servicing the warranties will be $120,000 for two years. Because the repair costs are not incurred evenly, warranty revenues are recognized based on the proportion of costs incurred out of the total estimated costs.
(c) What amounts would be shown on Selzer's income statement under parts (a) and (b)? Explain the resulting difference in the company's net income.
(d) Assume that the equipment sold by Selzer undergoes technological improvements and management now has no past experience on which to estimate the extent of the warranty costs. The chief engineer believes that product warranty costs are likely to be incurred, but they cannot be reasonably estimated. What advice would you give on how to account for and report the warranties?