All machines are sold subject to a 5 year warranty. It is estimated that the exp

Question

All machines are sold subject to a 5 year warranty. It is estimated that the expense ultimately to be incurred in connection with the warranty will amount to 1/2 of 1% of sales. The company has charged an expense account for warranty costs incurred. Sales per books and warranty costs were as follows.

Year Ended March 31

Prepare the journal entry or entries you would give the bookkeeper to correct the books. Assume the books have not yet been close for the fiscal year ended March 31, 2015. Disregard correction of income taxes.

Note: This is an error analysis and correcting entries problem

Warranty Expense for Sales Made in

Year Ended March 31

Sales 2013 2014 2015 Total 2013 $940,000 760 760 2014 1,010,000 360 1,310 1,670 2015 1,795,000 320 1,620 1,910 3,850

Explanation / Answer

Answer:

As given in the question the has an estimate that the ultimate warranty cost will be equal to half of 1% os Sales during a year and products are sold with 5 years warranty. Therefore, as per the common accounting parlence, the Company must be creating a reserve fund to service the warranty expenses to be incurred upt five years of sale on the basis of its estimations. Therefore, the estimated annual warranty expense must have been created and charged to Income Statement. Any warranty expense incured must be charged to the reserve account and not to an expense account.

The above amounts of estimated warranty expense must be provided for every year till 5th year of sale by debiting income statement and crediting a Provision Account for future liabilities. And as and when actual warranty expenses are incurred by the Company, they must be debited to Provision account and credited to Cash or Bank Account.

Correct Journal Entries that must have been done

2013

Dr. Warranty Expense Account                                   $ 940

Cr. Warranty Expense Payable                                                                  $ 940

(being estimated warranty expenses provided for)

Dr. Warranty Expense Payable Account                        $ 760

Cr. Cash or Bank                                                                                     $ 760

(being actual warranty expenses incurred)

2014

Dr. Warranty Expense Account                                   $ 1,950 ($ 940 + $ 1,010)

Cr. Warranty Expense Payable                                                                  $ 1,950

(being estimated warranty expenses provided for)

Dr. Warranty Expense Payable Account                        $ 1,670 ($ 360 + $ 1,310)

Cr. Cash or Bank                                                                                     $ 1,670

(being actual warranty expenses incurred)

2015

Dr. Warranty Expense Account                                   $ 3,745 ($ 940 + $ 1,010 + $ 1,795)

Cr. Warranty Expense Payable                                                                  $ 3,745

(being estimated warranty expenses provided for)

Dr. Warranty Expense Payable Account                        $ 3,850

Cr. Cash or Bank                                                                                     $ 3,850

(being actual warranty expenses incurred)

Year Sales Estimated Total Warranty Cost to be apportioned equally in five years 2013 2014 2015 2013 $ 940,000 half of 1% of Sales = $ 4,700 $ 940 $ 940 $ 940 2014 $ 1,010,000 $ 5,050 NIL $ 1,010 $ 1,010 2015 $ 1,795,000 $ 8,975 NIL NIL $ 1,795

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