Question

Schmitt Company must make computations and adjusting entries for the following independent situations at December 31, 2018.

1. Its line of amplifiers carries a 3-year warranty against defects. On the basis of past experience the estimated warranty costs related to dollar sales are first year after sale—2% of sales revenue; second year after sale—3% of sales revenue; and third year after sale—5% of sales revenue. Sales and actual warranty expenditures for the first 3 years of business were:

	Sales Revenue	Warranty Expenditures
2016	\(800,000	\)6,500
2017	1,100,000	17,200
2018	1,200,000	62,000

Instructions

Compute the amount that Schmitt should report as a liability in its December 31, 2018, balance sheet. Assume that all sales are made evenly throughout each year with warranty expenses also evenly spaced relative to the rates above.

2. With some of its products, Schmitt includes coupons that are redeemable in merchandise. The coupons have no expiration date and, in the company’s experience, 40% of them are redeemed. The liability for unredeemed coupons at December 31, 2017, was \(9,000. During 2018, coupons worth \)30,000 were issued, and merchandise worth $8,000 was distributed in exchange for coupons redeemed.

Instructions

Compute the amount of the liability that should appear on the December 31, 2018, balance sheet

Short answer

(1) The amount to be reported as warranty liability equals $224,300.

(2) The amount to be reported for liability of outstanding premium claims equals $13,000.

Step-by-step solution

(1) Calculation of warranty expense

Particulars	Amount
Estimated warranty costs rate (2% + 3% + 5%)	10%
For 2016 : ($800,000 x 10%)	$80,000
For 2017 : ($1,100,000 x 10%)	$110,000
For 2018 : ($1,200,000 x 10%)	$120,000
Total estimated costs	$310,000
Less: Total warranty expenditure ($6,500+$17,200+$62,000)	(85,700)
Liability balance, Dec. 31, 2018	$224,300

(2) Calculation of warranty liability

Particulars	Amount
Unredeemed coupons ($9,000 -$8,000)	$1,000
Add: Estimated coupons to be redeemed ($30,000 x 0.40)	12,000
Liability for premium claims outstanding	$13,000