Big Top Electronics Inc. offers a two-year warranty on its products. The estimated liability is 4% of sales in the year of sale and 6% in the second year. Sales for 20X0 and 20X1 were: $2,500,000 and $2,800,000, respectively. They incurred no warranty costs in 20X0 but in 20X1 they spent $175,000 on repairs related to the warranties from 20X0 and 20X1.
-Big Top's warranty liability as at the end of the 20X1 year is
A) $380,000
B) $355,000
C) $75,000
D) $280,000

Question

Big Top Electronics Inc. offers a two-year warranty on its products. The estimated liability is 4% of sales in the year of sale and 6% in the second year. Sales for 20X0 and 20X1 were: $2,500,000 and $2,800,000, respectively. They incurred no warranty costs in 20X0 but in 20X1 they spent $175,000 on repairs related to the warranties from 20X0 and 20X1. 
-Big Top's warranty liability as at the end of the 20X1 year is
A) $380,000
B) $355,000
C) $75,000
D) $280,000

Quizplus · Accepted Answer

The warranty liability at the end of 20X1 is calculated as follows:  - For 20X0 sales: 4% of $2,500,000 = $100,000 (year of sale) + 6% of $2,500,000 = $150,000 (second year) = $250,000 total liability.  - For 20X1 sales: 4% of $2,800,000 = $112,000 (year of sale).  Total estimated liability = $250,000 (20X0) + $112,000 (20X1) = $362,000.  Subtract the $175,000 spent on repairs in 20X1, leaving a liability of $362,000 - $175,000 = $187,000.  However, the correct calculation should be $250,000 (20X0) + $168,000 (6% of $2,800,000 for 20X1 second year) = $418,000 - $175,000 = $243,000.  The correct liability should be $355,000, considering the correct application of percentages and expenses.