Question

From 1 July 2019, Prowess Ltd developed and began selling a new product, the iFeel tablet which was capable of responding to human emotions. The company had previously sold computer monitors and was excited by the prospect of branching out into a new and very innovative product line. The company offers customers an extended warranty period of 3 years on the iFeel tablet. At 30 June 2020, management has estimated that two percent of products would be returned for repair at an estimated annual cost of $650,000 per annum based on predicted annual sales volumes.

Required:

Using the relevant definitions and recognition criteria found in the AASB Framework for the Preparation and Presentation of Financial Statements, justify whether the company should account for the extended warranty as a liability.

Answer 1

Warranty Expenses: It is a expense which the business expects to or has already incurred for the repair or replacement of goods that it has sold.

Extended Warranty: It is like an additional gift given to the customer either for some cost or for free. in the above case it is provided for free to the customers.

Extended warranty is also a liability for the company because in the above case it is provided for free to the customers so it will be treated in the same way we treat our normal warranty.

In the above case , the expected repairing cost will be 2% of the sales volume and this 2% will be equal to 650000.

The transaction whould be recorded as:

warranty expenses Dr. 650000

To Cash 650000.