Extended warranties

Carnes Electronics sells consumer electronics that carry a 90-day manufacturer’s warranty. At the time of purchase, customers are offered the opportunity to also buy a two-year extended warranty for an additional charge. During the year, Carnes received $412,000 for these extended warranties (approximately evenly throughout the year).

Required:

1.Does this situation represent a loss contingency? Why or why not? How should it be accounted for?

2.Prepare journal entries that summarize sales of the extended warranties (assume all credit sales) and any aspects of the warranty that should be recorded during the year.

Solution :

1. This is not a loss contingency as extended warranty is being priced as well sold separately from warranted products and therefore constitutes the separate sales transaction.

2.

Event    General Journal                                                  Debit          Credit

1           Cash                                                                   $412,000

          Unearned revenue -- extended warranties                           $412,000

2.      Unearned revenue -- extended warranties       $ 57937.50

          Revenue - Extended Warranties                                           $ 57937.50

Working :

The manufacturer provided 90 days which is 3 months of free warranty. Thus a customer who is purchasing the extended warranty is for 09 months.

Now amount received by Carnes Electronics for the extended warranty in one year = $412,000

So, [tex]$\$ 412,000 \times \frac{9}{12}= \$309000$[/tex]   of sales.

The warranty is for two years and so 4.5 months in one year.

Therefore the revenue earned on the extended warranty is :

[tex]$\$309000 \times \frac{4.5 \text{ months}}{24 \text{ months}}$[/tex]

= $ 57937.50

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