Exercise 9-6A Effect of Warranties on Income and Cash Flow

Accounting for Current Liabilities and Payroll

Exercise 9-6A Effect of Warranties on Income and Cash Flow

To support herself while attending school, Daun Deloch sold stereo systems to other students. During the first year of operations, Daun purchased the stereo systems for $140,000 and sold them for $250,000 cash. She provided her customers with a one-year warranty against defects in parts and labor. Based on industry standards, she estimated that warranty claims would amount to 2 percent of sales. During the year, she paid $2,820 cash to replace a defective tuner.

Required

Prepare an income statement and statement of cash flows for Daun’s first year of operation. Based on the information given, what is Daun’s total warranties liability at the end of the accounting period?

Exercise 9-7A Effect of Warranty Obligations and Payments on Financial Statements

The Chair Company provides a 120-day parts-and-labor warranty on all merchandise it sells. The Chair Company estimates the warranty expense for the current period to be $2,650. During this period, a customer returned a product that cost $1,830 to repair.

Required

a. Show the effects of these transactions on the financial statements using a horizontal statements model like the example shown next. Use + for increase, − for decrease, and NA for not affected. In the Cash Flow column, indicate whether the item is an operating activity (OA), investing activity (IA), or financing activity (FA).

b. Prepare the journal entry to record the warranty expense for the period.

c. Prepare the journal entry to record payment for the actual repair costs.

d. Why do companies estimate warranty expense and record the expense before the repairs are actually made?