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1)An entity provided a 3 year warranty on one of its new products
1)An entity provided a 3 year warranty on one of its new products. Management expects that the cost of servicing the warranty as a % of cost will be as follows: 2% of cost in the first year 3% of cost in the second year, and 4% of cost in the third year. Total sales of the product in the first two years were $1,800,000 and $2,500,000 respectively. Warranty costs incurred in the first two years were $20,500 and $64,000 respectively. Assume a gross margin of 40%, what is the balance in the warranty liability account at the end of the second year?
2)
A former employee is suing the entity for wrongful dismissal in the amount of $500,000.
Legal counsel believes that the following probability distribution applies in this situation:
Payout Probability
$0 35%
$100,000 30%
$250,000 30%
$500,000 5%
Assess whether or a provision needs to be recorded. If you believe that a provision needs
to be recorded, calculate the amount of the provision.
Expert Solution
1)
| Calculation of Warranty Liability | ||
| Particulars | Year 1 | Year 2 |
| Sales | 1,800,000 | 2,500,000 |
| Less: Gross Profit @ 40% | (720,000) | (1,000,000) |
| Cost | 1,080,000 | 1,500,000 |
| Warranty expensed | 2% of cost | 3% of cost |
| Warranty expense to be recorded | 21,600 | 45,000 |
| Less: Actually warranty cost incurred | (20,500) | (64,000) |
| Warranty liability to be settled | 1,100 | (19,000) |
| Liability balance from previous year | - | 1,100 |
| Warranty liability at the end | 1,100 |
(17,900)
|
2)
| Provision is to be created when folowing conditions are satisfied | ||||||
| 1 | Present obligation as a result of past event - | |||||
| 2 | Outflow of future economic benefit | |||||
| 3 | Amount can be measured relaibly | |||||
| in the given situation all the condition are satisfied, Thus a provision needs to be recorded. | ||||||
| Amount of provision to be created | $ 130,000 | |||||
| Amount | Probability | Provision | ||||
| A | B | C *A*B | ||||
| $ - | 35% | $ - | ||||
| $ 100,000 | 30% | $ 30,000 | ||||
| $ 250,000 | 30% | $ 75,000 | ||||
| $ 500,000 | 5% | $ 25,000 | ||||
| Total provision | $ 130,000 | |||||
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