Question

Alvarado Company sells a machine for \(7,400 with a 12-month warranty agreement that requires the company to replace all defective parts and to provide the repair labor at no cost to the customers. With salesbeing made evenly throughout the year, the company sells 600 machines in 2017 (warranty expense is incurred half in 2017and half in 2018). As a result of product testing, the company estimates that the total warranty cost is \)390 per machine (\(170parts and \)220 labor).

Instructions

Assuming that actual warranty costs are incurred exactly as estimated, what journal entries would be made relative to the followingfacts?

(a) Sale of machinery and warranty expense incurred in 2017.

(b) Warranty accrual on December 31, 2017.

(c) Warranty costs incurred in 2018.

(d) What amount, if any, is disclosed in the balance sheet as a liability for future warranty costs as of December 31, 2017?

Short answer

(a) Cash will be debited and sales revenue will be credited by $4,440,000, respectively.

Warranty expense will be debited and Cash, Inventory, Accrued Payroll will be credited by $117,000, respectively.

(b) Warranty expense will be debited and warranty payable will be credited by $117,000, respectively.

(c)Warranty expense will be debited and Cash, Inventory, Accrued Payroll will be credited by $117,000, respectively.

(d)As on December 31, 2017, Warranty payable of $117,000 will be reported under current liability in balance sheet.

Step-by-step solution

(a) Journal entry

Date	Accounts & Explanations	Debit	Credit
2017	Cash (600 x $7,400)	$4,440,000
	Sales Revenue		$4,440,000
	To record sales revenue
2017	Warranty Expense ((600 x $390) / 2)	$117,000
	Cash, Inventory, Accrued Payroll		$117,000
	To record warranty expense

(b) Journal entry

Date	Accounts & Explanations	Debit	Credit
Dec. 31, 2017	Warranty Expense ((600 x $390) / 2)	$117,000
	Warranty Liability		$117,000
	To record accrued warranty expense

(c) Journal entry

Date	Accounts & Explanations	Debit	Credit
2018	Warranty Expense ((600 x $390) / 2)	$117,000
	Cash, Inventory, Accrued Payroll		$117,000
	To record warranty expense

(d) Reporting in balance sheet

In the balance sheet, half of total warranty expense of $234,000 will be reported as current liability related warranty liability. Hence, $117,000 would be reported as warranty liability.