Question

Bears Inc. sells football helmets to local schools and warrants all of its products for one year. While no helmets sold in 2018 have been returned yet, based upon previous years, Bears Inc. estimates that 3% of its products will need repairs or be replaced within the next year. What effect would this warranty have on assets, liabilities, and stockholders' equity in 2018

Answer 1

A. A decrease in assets and decrease in Stockholders' equity.

B. No journal entry in necessary until products under warranty are returned.

C. An increase in stockholders' equity and a decrease in liabilities.

D. A decrease in stockholders' equity and an increase in liabilities.

Answer: D. A decrease in stockholders' equity and an increase in liabilities.

Explanation: Liability can simply be described as debt or what is owed by a firm, whereas the equity of the stockholders refers to assets or possession of a firm once liabilities have been deducted. In the scenario above, the expected returns have not been made as envisaged based on data from previous years, the 3% expected return which is covered by warranty will be added to liability which means liability increases as the buyers are either refunded or issued new helmets. Once liability increases, stockholders equity will also decrease as it involves the deduction of liabilities.