Zach Corporation sells laptop computers under a two-year warranty contract that requires the corporation to replace defective parts and to provide the necessary repair labor. During 2006 the corporation sells for cash 400 computers at a unit price oc $2,000. On the basis of past experience, two-year warranty costs are estimated to be $90 for parts and $100 for labor per unit. (For simplicity, assume that all sales occurred on December 31, 2006, rather than evenly throughout the year.)
Instructions:
(a) Record any necessary journal entries in 2006, applying the cash basis method.
(b) Record any necessary journal entries in 2006, applying the expense warranty accrual method.
(c) What liability relative to these transactions would appear on the December 31, 2006 balance sheet and how would it be classified if the cash basis method was applied.
(d) What liability relative to these transactions would appear on the December 31, 2006 balance sheet and how would it be classified if the expense warranty accrual method is applied.
In 2007 the actual warranty costs to Zack Corporation were $14,800 for parts and $18,200 for Labor.
(e) Record any necessary journal entries in 2007, applying the cash basis method.
(f) Record any necessary journal entries in 2007, applying the expense warranty accrual method.
(g) Under what conditions is it acceptable to use the cash basis method? Explain.