Computer Wholesalers restores and resells notebook computers. It originally acquires the notebook computers from corporations upgrading their computer systems, and it backs each notebook it sells with a 90-day warranty against defects. Based on previous experience, Computer Wholesalers expects warranty costs to be approximately 4% of sales. Sales for the month of December are $400,000. Actual warranty expenditures in January of the following year were $13,000. Required:1. Does this situation represent a contingent liability?2. & 3. Record the necessary entries in the Journal Entry Worksheet below.4. What is the balance in the Warranty Liability account after the entries in Parts 2 and 3?
Question
Computer Wholesalers restores and resells notebook computers. It originally acquires the notebook computers from corporations upgrading their computer systems, and it backs each notebook it sells with a 90-day warranty against defects. Based on previous experience, Computer Wholesalers expects warranty costs to be approximately 4% of sales. Sales for the month of December are 13,000. Required:1. Does this situation represent a contingent liability?2. & 3. Record the necessary entries in the Journal Entry Worksheet below.4. What is the balance in the Warranty Liability account after the entries in Parts 2 and 3?
Solution
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Yes, this situation represents a contingent liability. A contingent liability is a potential liability that may occur in the future, such as warranty claims. In this case, Computer Wholesalers offers a 90-day warranty on its products, which means it has an obligation to repair or replace products that have defects within this period. This obligation is a contingent liability because it depends on the occurrence of a future event, i.e., the discovery of a defect in a product.
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& 3. The necessary journal entries would be:
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In December (when the sales were made): Debit: Warranty Expense 16,000
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In January (when the actual warranty expenditures were made): Debit: Warranty Liability 13,000
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The balance in the Warranty Liability account after the entries in Parts 2 and 3 would be 16,000 - $13,000). This is the amount that Computer Wholesalers expects to pay in the future for warranty claims related to the sales made in December.
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