Products in a manufacturing environment are often sold with a warranty-a promise to repair or replace a product that malfunctions during a designated period. In recent years, based on a competitive economy, many companies are extending this warranty for longer periods. GAAP requires that the expense for these warranties be recorded to match with the product sale. Therefore, a product sold in 20XX with a five-year warranty needs to have an estimate of its future warranty claims expensed in 20XX, although many of those claims may not result for five years. This is an area of great scrutiny and judgment for both auditors and clients alike.
Tanner, CPA, is conducting a second-year audit on its client, Lucas Manufacturing, Inc. Lucas Manufacturing offers a standard five-year warranty on all products sold. The client calculates its accrued product warranty based on historical trends in warranty claims and claims incurred to-date. Traditionally, its estimates have proven reliable. Tanner, CPA, is ready to audit the accrued product warranty for the period 20XX.
1). How should Tanner, CPA, approach the audit of Lucas Manufacturing's accrued warranty if the products sold are consistent with prior years?
2). Would Tanner's audit approach be different if a brand new product was sold in the current year (20XX)?
3). What else (in addition to sales and claims history and product mix) should Tanner consider?