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:

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?

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

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:

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:

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:

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:

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:

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

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

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