. During Year One, Company A and Company Z both sell 1,000 computers for $1,000

Question

. During Year One, Company A and Company Z both sell 1,000 computers for $1,000 each in cash. Company A provides a one-year warranty to its customers for free. Company Z sells a one-year warranty to all of its customers for $50 each. Both companies expect 5 percent of the computers to break and cost $600 each to repair. In Year Two, both companies actually have 6 percent of these computers break. However, the required cost to fix each one was only $550.

a. In financial reporting for Year One, which company will report the highest amount of net

income? What will be the difference in the two reported amounts?

b. In financial reporting for Year Two, which company will report the highest amount of net

income? What will be the difference in the two reported amounts?

Explanation / Answer

a. Year 1 earnings :

- $30000

b. Year 2 earnings :

-$33000

   Company A Company Z Difference of reported amounts Sales revenue 1000*$1000 = $1,000,000 1000*$1000 = $1,000,000 Add: Service revenue 0 1000*$50 = $50,000 Total revenue $1,000,000 $1,050,000 Less: cost of repair (on warranty) 1000*5%*$600 = -$30000

- $30000

Net income $970,000 $1,020,000 $50000, which is the service revenue difference

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