Question

You have obtained the following extract from the financial statements of a leading computer manufacturer. The aggregate product warranty liabilities were as follows for the following fiscal years ended October 31. In the year of 2012, product warranty liability at the beginning of year is $2,451. In the year of 2012, accruals for warranties issued are $2,370. In the year of 2012, settlements made for warranties are $2,251. In the year of 2012, product warranty liability at the end of year is $2,570. In the year of 2011, product warranty liability at the beginning of year is $2,447. In the year of 2011, accruals for warranties issued are $2,624. In the year of 2011, settlements made for warranties are $2,620. In the year of 2011, product warranty liability at the end of year is $2,451.

1. Based on the above information, how much of the company’s economic resources were used in 2012 to honour its products under warranty?

2. Assume you are the auditor of the company and have reliably measured the total revenues of the company as $75,000 in the year of 2012. Historically, the company has reported an average warranty expense of 3% of total revenues. If the 3% figure is correct, by how much has the company overstated or understated its warranty expense for the year ended October 31, 2012?

Answer 1

1. In the year 2012, the accrual for warranty expense was $2370. Though it was the warranty expense recorded for 2012, it was not the actual economic resources used to honor the warranty in 2012.

The actual economic resources used to honor the warranty in 2012 was $2251 which was the amount that was spent to settle the warranty claims in 2012.

2. The sale of 2012=$75000

Required Warranty accrual @3% of revenue =$2250

Actual accrual made in 2012 =$2370

Over Accrual in 2012 = $2370-$2250=$120