Rotary Tools sells power tools and backs each product it sells with a one-year w

Question

Rotary Tools sells power tools and backs each product it sells with a one-year warranty against defects. Based on previous experience, the company expects warranty costs to be approximately 4% of sales. By the end of the first year, sales are $800,000. Actual warranty expenses incurred so far are $12,000.


1. Does this situation represent a contingent liability?

2. Record warranty expense and warranty liability for the year based on 4% of sales

3. Record the actual warranty expenditures of $12,000 incurred so far

4. What is the balance in the Warranty Liability account after the entries in parts 2 and 3?

Explanation / Answer

Q1. True. Warranty liability is a contingent liability that is probable but this is capable of making a estiamte hence recorded in books. Q2. Journal Entry: Warranty expense Account Dr. 32,000      Estimated Warranty Liability Account (800000*4%) 32000 Q3. Journal Entry: Estimated Warranty Liability Account Dr. 12000        Cash account 12000 Q4. Balance in Estimated warranty Lliability: Amount of liability created 32000 Less: Liability paid off during the year 12000 Balance in Estimated warranty Lliability: 20000

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