Brooks Inc. sells portable computer equipment with a two-year warranty contract that requires the corporation to replace defective parts and provide the necessary repair labour. During 2017, the corporation sells for cash 400 computers at a unit price of $2,500. Based on experience, the two-year warranty costs are estimated to be $155 for parts and $185 for labour per unit. (For simplicity, assume that all sales occurred on December 31, 2017.) The warranty is not sold separately from the equipment, and no portion of the sales price is allocated to warranty sales. Brooks follows ASPE.
Instructions
Answer parts (a) to (d) based on the information above.
(a) Record the 2017 journal entry, assuming the cash basis is used to account for the warranties.
(b) Record the 2017 journal entries, assuming the accrual basis under the assurance-type approach is used to account for the warranties.
(c) What liability relative to these transactions would appear on the December 31, 2017 balance sheet? How would it be classified if the cash basis is used?
(d) What liability relative to these transactions would appear on the December 31, 2017 balance sheet? How would it be classified if the accrual basis assurance-type approach is used?
Answer parts (e) to (h) assuming that in 2018 the actual warranty costs incurred by Brooks were $21,400 for parts and $39,900 for labour.
(e) Record the necessary entry in 2018, applying the cash basis.
(f) Record the necessary entry in 2018, applying the accrual basis assurance-type approach.
(g) Which method of accounting for warranties would you recommend to Brooks? Why?
(h) Assume that the warranty costs incurred by Brooks in 2019 were substantially higher than estimated. How would Brooks deal with the discrepancy between the estimated warranty liability and the actual warranty expense?