Question

Cupola Awning Corporation introduced a new line of commercial awnings in 2016 they carry a two year warranty against manufacturer's defects. based on their experience with previous product introductions, warranty costs are expected to approximate 3% of sales. sales and actual warranty expenditures for this first year of selling the product were:

Sales = $5,000,000
Actual Warranty Expenditures = $37,500

1. does this situation represent a loss contingency? why or why not? How should cupola account for it?

2. prepare journal entries that summarize sales of the awnings (assume all credit sales) and any aspects of the warranty that should be recorded during 2016.

3. what amount should cupola report as a liability at December 31, 2016?

Answer 1

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Requirement 1
This is a loss contingency. There may be a future sacrifice of economic benefits (cost of satisfying the warranty) due to an existing circumstance (the warranted awnings have been sold) that depends on an uncertain future event (customer claims).
The liability is probable because product warranties inevitably entail costs. A reasonably accurate estimate of the total liability for a period is possible based on prior experience.
So, the contingent liability for the warranty is accrued. The estimated warranty liability is credited and warranty expense is debited in 2016, the period in which the products under warranty are sold.
Requirement 2
Accounts	Debit	Credit
Accounts receivable	$               5,000,000
Sales		$5,000,000
(To record sale)
Accrued liability and expense
Warranty expense (3% x $5,000,000)	$                  150,000
Estimated warranty liability		$   150,000
(To record warranty expense)
Estimated warranty liability	$                    37,500
Cash, wages payable, parts and supplies, etc.		$     37,500
(To record actual Expense)
Requirement 3
Warranty liability to be reported $150,000-$27,500	$                  112,500