Question

1. Jordan Tire Co. sells tires and guarantees them as long as the customer owns them. If a tire fails, the customer is charged a percentage of the retail price based on the percentage of the tire that is worn, plus a service charge for putting the tire on the ear. In the past, management found that only 2 percent of the tires sold required replacement under warranty, and of those replaced an average 20 percent of the cost is collected under the percentage pricing system. The average tire costs the company $55. At the beginning of July, the account for estimated liability for product warranties had a credit balance of $22,746. During July, 125 tires were returned under the warranty. The cost of the replacement tires was $4,625, of which $1,125 was recovered under the percentage-worn formula. Service revenue amounted to $531. During the month, the company sold 3,525 tires.

Required

1.)  Prepare general journal entries to record each of the following:   

(a)  the warranty work completed during the month including related revenues;   

(b)  the estimated liability for product warranties for tires sold during the month.

2. Compute the balance of the estimated product warranty liability at the end of the month.

Answer 1

1. a)

Particulars	Debit	Credit
Liability for product warranties (Cost of replacement tires)	4625
Service Charge		531
Cost recovered from customer as per worn out %		1125
Cost borne on replacement (Balancing figure)		2969

1. b)

Cost to be borne on replacement	3102
Liability for product warranties (3525 tires sold * 2% required replacement * 44 (55*80%) cost to be borne by company)		3102

2.

Opening liability for product warranties	22746
Add: Liability for the current month	3102
Less: Net cost of replacement of tires (4625-1125)	-3500
Closing liability for product warranties	22348