Brooks Corporation sells portable computer equipment

Brooks Corporation sells portable computer equipment with a two-year warranty contract that requires the corporation to replace defective parts and provide the necessary repair labour. During 2011, the corporation sells for cash 400 computers at a unit price of $2,500. Based on experience, the two-year warranty costs are estimated to be $155 for parts and $185 for labour per unit. (For simplicity, assume that all sales occurred on December 31, 2011.) The warranty is not sold separately from the equipment, and no portion of the sales price is allocated to warranty sales.

Instructions

Answer (a) to (d) based on the information above.

(a) Record the 2011 journal entries, assuming the cash basis is used to account for the warranties.

(b) Record the 2011 journal entries, assuming the accrual basis expense approach is used to account for the warranties.

(c) What liability relative to these transactions would appear on the December 31, 2011 balance sheet and how would it be classified if the cash basis is used?

(d) What liability relative to these transactions would appear on the December 31, 2011 balance sheet and how would it be classified if the accrual basis expense approach is used? Answer (e) to (h) assuming that in 2012 the actual warranty costs incurred by Brooks Corporation were $21,400 for parts and $39,900 for labour.

(e) Record the necessary entries in 2012, applying the cash basis.

(f) Record the necessary entries in 2012, applying the accrual basis expense approach.

(g) Which method would you recommend to the company? Why?

(h) Assume that the warranty costs incurred by Brooks Corporation in 2013 were substantially higher than estimated.

How would the company deal with the discrepancy between the estimated warranty liability and the actual warranty expense?

(a)	Cash (400 X $2,500)............................................................	1,000,000
	Sales..........................................................................		1,000,000
(b)	Cash (400 X $2,500)............................................................	1,000,000
	Sales..........................................................................		1,000,000
	Warranty Expense ..............................................................	136,000
	Estimated Liability Under                  Warranties............................................................		136,000
	(400 X [$155 + $185])

(c)        No liability would be disclosed under the cash basis method relative to future costs due to warranties on past sales.

           

(d)	Current Liabilities:
	Estimated Liability Under Warranties			$68,000
	Long-term Liabilities:
	Estimated Liability Under Warranties			$68,000
(e)	Warranty Expense....................................................	61,300
	Parts Inventory...............................................			21,400
	Accrued Payroll.............................................			39,900
(f)	Estimated Liability Under Warranties....................	61,300
	Parts Inventory...............................................			21,400
	Accrued Payroll.............................................			39,900

(g)       The company should apply the accrual basis expense approach. This would result in better matching of warranty costs with the revenues that generate them. The cash basis would be acceptable only where the warranty costs are immaterial or when the warranty period is relatively short. This is not the case for Brooks Corporation. If the warranties were available separately or if the warranty price is considered to be bundled with the product (as a multiple deliverable) then the company should apply the accrual basis revenue approach.

(h)       Higher than predicted warranty expenditures will cause the Estimated Warranty Liability account to have an understated balance that will not be sufficient for future warranty obligations. Management must review actual warranty claims experience against the estimated warranty liability balances in order to adjust the rate used to record warranty expense in the current and future years. The discrepancy is treated as a change in an accounting estimate and is applied to the current and future periods. In 2013, management of Brooks Corporation would have to record a larger warranty expense in order to accurately measure the Estimated Warranty Liability.