During 2009, General Machinery company introduced a new line of machines that carry a three-year warranty against manufacturer's defects. Based on industry experience, warranty costs are estimated at 2% of sales in the year of sale, 4% in the year after sale, and 6% in the second year after sale. Sales and actual warranty expenditures for the first three-year period were as follows:

What amount should General Machinery report as a liability at December 31, 2011?

Question

During 2009, General Machinery company introduced a new line of machines that carry a three-year warranty against manufacturer's defects. Based on industry experience, warranty costs are estimated at 2% of sales in the year of sale, 4% in the year after sale, and 6% in the second year after sale. Sales and actual warranty expenditures for the first three-year period were as follows:

What amount should General Machinery report as a liability at December 31, 2011?

Quizplus · Accepted Answer

To calculate the liability for warranties, we must first estimate the warranty costs for each year using the percentage of sales method provided.

Year 1 Warranty Costs = 2% of $750,000 (Year 1 Sales) = $15,000
Year 2 Warranty Costs = 4% of $1,500,000 (Year 2 Sales) = $60,000
Year 3 Warranty Costs = 6% of $1,800,000 (Year 3 Sales) = $108,000

Total Warranty Costs = $15,000 + $60,000 + $108,000 = $183,000

However, not all of these costs will be recognized as a liability at December 31, 2011, since some of the costs will relate to future years. To determine the liability at December 31, 2011, we need to subtract the amounts that have already been recognized in previous years.

Year 1 Warranty Expenditures = $10,000
Year 2 Warranty Expenditures = $25,000
Year 3 Warranty Expenditures = $60,000

Total Warranty Expenditures = $10,000 + $25,000 + $60,000 = $95,000

Liability at December 31, 2011 = Total Warranty Costs - Warranty Expenditures Through Year 3
Liability at December 31, 2011 = $183,000 - $95,000 = $88,000

Therefore, the correct choice is D. $118,125 is not the correct answer as it represents the total estimated warranty costs for all three years, not the liability at December 31, 2011.

During 2009, General Machinery Company Introduced a New Line of Machines