Question

Hill Corp. began production of a new product. During the first calendar year, 1,000 units of the product were sold for $1,200 per unit. Each unit had a two-year warranty. Based on warranty costs for similar products, Hill estimates that warranty costs will average $100 per unit. Hill incurred $12,000 in warranty costs during the first year and $22,000 in warranty costs during the second year. The company uses the expense warranty accrual method. What should be the balance in the estimated liability under warranties account at the end of the first calendar year

Answer 1

Answer:

$88,000

Explanation:

(1,000 units × $100 estimated warranty cost per unit) $100,000

Therefore:

($100,000 - $12,000 actual warranty costs incurred during the first year) $88,000

Liability for warranty costs is recognized when the related revenue is recognized. In a situation were the warranty covers a period longer than the period in which the product is sold, the entire liability for the expected warranty costs must be recognized on the day the product is actually sold.

Therefore in the first calendar year a warranty liability of $100,000 (1,000 units × $100 estimated warranty cost per unit) was recognized. Actual payments for warranty costs reduce the amount of warranty liability recognized. Thus, at the end of the first calendar year, the balance of the warranty liability is $88,000 ($100,000 warranty liability initially recognized - $12,000 actual warranty costs incurred during the first year).