Fail-Safe Computer Inc. sells equipment with a 2-year warranty. Prior experience indicates that costs for warranty repairs average 3% in the first year, and 2% in the second year. Sales were $300,000 and $400,000 in fiscal 2019 and 2020 respectively. It paid $5,000 for materials and labour to make warranty-related repairs in 2019. What amount will be recorded as warranty expense in 2019?
A)$5,000
B)$12,000
C)$15,000
D)$18,000

Question

Quizplus · Accepted Answer

The amount recorded as warranty expense in 2019 can be calculated as follows:

Warranty repairs costs in 2019 = Sales in 2019 x Percentage of warranty repairs in the first year
= $300,000 x 3% = $9,000

Total warranty repairs costs over the warranty period = Warranty repairs costs in the first year + Warranty repairs costs in the second year
= $9,000 + ($400,000 x 2%) = $9,000 + $8,000 = $17,000

Therefore, the amount recorded as warranty expense in 2019 is the proportion of the total warranty repairs costs that can be attributed to sales in 2019:

Warranty expense in 2019 = (Warranty repairs costs in 2019 / Total warranty repairs costs) x Total warranty repairs costs incurred
= ($9,000 / $17,000) x $5,000 = $2,647

However, the question is asking for the amount recorded as warranty expense in 2019, which is not equal to the warranty repairs costs incurred in 2019. This is because some of the warranty repairs costs incurred in 2019 may relate to sales made in 2020. We do not know the exact portion of the warranty repairs costs that can be attributed to sales in 2019 and sales in 2020, so we must use an estimate.

One common estimate is to allocate the warranty repairs costs based on the proportion of sales in each year. Using this method, the warranty expense in 2019 can be calculated as:

Warranty expense in 2019 = Sales in 2019 / Total sales x Total warranty repairs costs incurred
= $300,000 / ($300,000 + $400,000) x $17,000
= $300,000 / $700,000 x $17,000
= $7,286

This method assumes that the proportion of warranty repairs costs incurred in 2019 to sales in 2019 is the same as the proportion of warranty repairs costs incurred in 2020 to sales in 2020. While this may not be exactly true, it is a reasonable assumption based on past experience.

Therefore, the best choice is C) $15,000, since this is the closest option to the calculated estimate of $7,286.