Adams’s Lawn Equipment sells high-quality lawn mowers and offers a 3-year warran

Question

Adams’s Lawn Equipment sells high-quality lawn mowers and offers a 3-year warranty on all new lawn mowers sold. In 2017, Adams sold $329,000 of new specialty mowers for golf greens for which Adams’s service department does not have the equipment to do the service. Adams has entered into an agreement with Mower Mavens to provide all warranty service on the special mowers sold in 2017. Adams wishes to measure the fair value of the agreement to determine the warranty liability for sales made in 2017. The controller for Adams’s Lawn Equipment estimates the following expected warranty cash outflows associated with the mowers sold in 2017.

Year

Cash Flow
Estimate

Probability
Assessment

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Using expected cash flow and present value techniques, determine the value of the warranty liability for the 2017 sales. Use an annual discount rate of 5%. Assume all cash flows occur at the end of the year.

Year

Cash Flow
Estimate

Probability
Assessment

2018 $2,370 20% 4,150 60% 4,590 20% 2019 $3,070 30% 4,540 50% 6,310 20% 2020 $3,840 30% 6,530 40% 6,400 30%

Explanation / Answer

Cash Flow Probability Warranty Cash outflow Total cash flow for the year for warranty PVIF@5% Present worth of Warrant liability Year Estimate Assessment 1 2018 2370 20% 474 4,150 60% 2490 4,590 20% 918 3882 0.952381 3697.143 2019 3070 30% 921 4,540 50% 2270 6,310 20% 1262 4453 0.907029 4039.002 2020 3840 30% 1152 6,530 40% 2612 6,400 30% 1920 5684 0.863838 4910.053 Total value of warranty Liability for 2017 sales 12646.2

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