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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281

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BuyFindarrow_forward

Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281
Textbook Problem
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Assurance-Type Warranty Clean-All Inc. sells washing machines with a 3-year assurance-type warranty. In the past, Clean-All has found that in the year after sale, warranty costs have been 3% of sales; in the second year after sale, 5% of sales; and in the third year after sale, 7% of sales. The following data are also available:

Chapter 9, Problem 14P, Assurance-Type Warranty Clean-All Inc. sells washing machines with a 3-year assurance-type warranty.

Required:

  1. 1. Prepare the journal entries for the preceding transactions for 2019–2021. Closing entries are not required.
  2. 2. What amount would Clean-All report as a liability on its December 31, 2021, balance sheet, assuming the liability had a balance of $88,200 on December 31, 2018?
  3. 3. Next Level How would the failure to recognize a contingent liability affect the financial statements?

1.

To determine

Journalize the transactions for the year 2019-2021 in the books of Incorporation CA.

Explanation

Warranty:

Warranty is a written guarantee that is given by the seller to the buyer for the product against product’s defect.

Prepare the journal entry to record the sales for the year 2019:

DateAccount titles and explanationDebit ($)

Credit

($)

2019Cash or Accounts receivable500,000 
 Sales 500,000
 (To record the sale revenue)  

Table (1)

  • Cash or an account receivable is an asset account and it is increased. Thus, debit cash or accounts receivable with $500,000.
  • Sales are a revenue account and it increases the shareholders’ equity. Thus, credit sales with $500,000.

Prepare the journal entry to record the estimated warranty liability for the year 2019:

DateAccount titles and explanationDebit ($)

Credit

($)

2019Warranty expense (1)75,000 
 Estimated warranty liability 75,000
 (To record the estimated warranty liability)  

Table (2)

Working note (1):

Determine the amount of estimated warranty liability.

Estimated warranty liability =[Sales ×Percentage of estimatedwarranty cost of sale]=$500,000×(3%+5%+7%)=$75,000

  • Warranty expense is an expense account and it decreases the value of shareholders’ equity. Thus, debit warranty expense with $75,000.
  • Estimated warranty liability is a liability and it is increased. Thus, credit estimated warranty liability with $75,000.

Prepare the journal entry to record the warranty cost incurred during the year 2019:

DateAccount titles and explanationDebit ($)

Credit

($)

2019Estimated warranty liability62,000 
 Cash or other assets 62,000
 (To record the warranty cost incurred during the year)  

Table (3)

  • Estimated warranty liability is a liability and it is decreased. Thus, debit estimated warranty liability with $62,000.
  • Cash or other asset is an asset account and it is decreased. Thus, credit cash or other assets with $62,000.

Prepare the journal entry to record the sales for the year 2020:

DateAccount titles and explanationDebit ($)

Credit

($)

2020Cash or Accounts receivable650,000 
 Sales 650,000
 (To record the sale revenue)  

Table (4)

  • Cash or an account receivable is an asset account and it is increased. Thus, debit cash or accounts receivable with $650,000.
  • Sales are a revenue account and it increases the shareholders’ equity. Thus, credit sales with $650,000.

Prepare the journal entry to record the estimated warranty liability for the year 2020:

DateAccount titles and explanationDebit ($)

Credit

($)

2020Warranty expense (2)97,500 
 Estimated warranty liability 97,500
 (To record the estimated warranty liability)  

Table (5)

Working note (2):

Determine the amount of estimated warranty liability.

Estimated warranty liability =[Sales ×Percentage of estimatedwarranty cost of sale]=$650,000×(3%+5%+7%)=$97,500

  • Warranty expense is an expense account and it decreases the value of shareholders’ equity

2.

To determine

Determine the amount of liability that would be reported by Incorporation CA on its December 31, 2021 balance sheet.

3.

To determine

Explain the manner in which the financial statements are affected for not recognizing the contingent liability.

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