Reliance Company manufactures and sells wireless video cell phones, which it guar- antees for five years. If a cell phone fails, it is replaced free, but the customer is charged a service fee for handling. In the past, management has found that only 3 percent of the cell phones sold required replacement under the warranty. The average cell phone costs the company $240. At the beginning of September, the account for estimated liability for product warranties had a credit balance of $208,000. During September, 250 cell phones were returned under the warranty. The company collected $9,860 of service fees for handling. During the month, the company sold 2,800 cell phones.
Required:
1. Prepare journal entries to record (a) the cost of cell phones replaced under warranty and (b) the estimated liability for product warranties for cell phones sold during the month.
2. Compute the balance of the Estimated Product Warranty Liability account at the end of the month.
3. If the company's product warranty liability is underestimated, what are the effects on current and future years' income?