Volt Electronics sells equipment that includes a three-year warranty. Repairs under the warranty are performed by an independent service company under contract with Volt. Based on prior experience, warranty costs are estimated to be $25 per item sold. Volt should recognize these warranty costs:
A) When the equipment is sold.
B) When the repairs are performed.
C) When payments are made to the service firm.
D) Evenly over the life of the warranty.

Question

Quizplus · Accepted Answer

The warranty costs should be recognized when the equipment is sold. This is because the cost of the warranty is a part of the cost of the equipment, and should be matched with the revenue generated from the sale of the equipment in the same accounting period. Recognizing the cost when repairs are performed or payments are made to the service firm would result in mismatching expenses with revenues and inaccurate financial reporting. Evenly spreading the costs over the life of the warranty would be inappropriate since it does not reflect the expenses incurred in the same period as the revenue.

Volt Electronics Sells Equipment That Includes a Three-Year Warranty