Arden\'s Used Cars offers a one-year warranty from the date of sale on all cars.

Question

Arden's Used Cars offers a one-year warranty from the date of sale on all cars. From historical data, Mr. Arden estimates that, on average, each car will require the company to incur warranty costs of $760. The following activities occurred during 2014 1 February 2 Sold five cars 2 March 23 Sold ten cars 3 May 30 4 July 5 5 September 28 Incurred warranty costs of $5,000 on five cars sold in 2014 6 November 15 Incurred warranty costs of $6,000 on one car sold in 2014 7 December 20 Sold twelve cars Incurred warranty costs of $3,000 in four cars sold in 2013 Sold eight cars a. Assume that the cars were sold for cash S9,500 each. Show journal entries to record the sales Prepare the individual entries to record the actual warranty costs incurred. Assume that warranty costs are paid in cash Arden accrues its warranty expense with a single adjusting entry at year-end. Prepare that entry The beginning balance in the contingent warranty liability account was $3,500. Show the warranty liability T-account, and compute the ending balance in the account Explain why accountants estimate the warranty expense in the year of sale instead of recording the expenses as the costs are actually incurred? Specifically, which two accounting principles is this treatment based on? b. c. d. e.

Explanation / Answer

(a) Sales Entry

(i) 2nd Feb 2014 Sales A/c dr 47500 [5x9500]

to Cash a/c 47500

(ii) 23rd March 2014 Sales A/c dr 95000 [10x9500]

to Cash a/c 95000

(iii) 5th July 2014 Sales A/c dr 76000 [8x9500]

to Cash a/c 76000

(iv) 20 th Dec 2014 Sales A/c 190000 [20x 9500]

to Cash a/c 190000

(b) Warranty Cost

(i) 30th May Warranty liabilities a/c dr 3000 [related to 2013, accrual entry already made in 2013]

to Cash a/c 3000

(ii) 28th Sep Warranty Cost a/c dr 5000

to cash a/c 5000

(iii) 15th Nov Warranty Cost a/c dr 6000

to Cash a/c 6000

3. Calculation of Accrued warranyty expenses

No of cars sold in 2014 = 5 + 10 + 8 + 12 = 35

Warranty expenses already incurred on 6 cars i.e. 5 + 1

Warrany expenses to be incurred in next year on balance cars sold in 2014 i.e. 35 - 6 = 29 cars

Estimated warranty cost is $ 760

Accrued warrabty cost = 29 cars x $ 760 = $ 22040

Warranty expenses a/c dr 22040

to Warranty liabilities a/c 22040

(v) Due to accrual & matching concept, accountant estimate the warranty expenses in the year of sale instead of actual incurred.

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