2. 6-1 Warranty Liability Using Service Contracts Chapter 6 Illustrated Solution: Exercise 6-20

3. 6-2  Warranties  Obligate the seller to bear repair costs for a specified time period.  Create an expense and estimated liability at the time of sale.  All estimated expenses are matched against revenues in the period when the item is sold.  No revenues or expenses are shown in future years. Background–Warranties

4. 6-3  Warranty Service Contracts  Customer pays fixed rate in advance for all repairs and/or maintenance for a specified time period. Services they are not entitled to under standard warranty.  Upon receipt, this payment creates a liability (unearned revenue) for the service provider.  Liability is reduced over the life of the service contract as revenue is earned.  Contract was priced originally so that revenues will exceed expenses (estimated) which will allow the provider to show a profit on the service contracts. Background–Warranty Service Contracts

5. 6-4 Warranty terms often cross multiple reporting periods. Example: Two-year warranty beginning June 1. Calendar Year 1: 7 months Calendar Year 2: 12 months Calendar Year 3: 5 months Calendar Years and Warranty Life Years

6. 6-5 Sales–Even Flow Assumption 2001 Contracts:$60  300 = $18,000 First year 40%=20% in 2001 + 20% in 2002

7. 6-6 Sales–Even Flow Assumption 2001 Contracts:$60  300 = $18,000 First year 40%=20% in 2001 + 20% in 2002 Jan 1 (12 months) and Dec 31 (0 months) =6 month average

8. 6-7 Sales–Even Flow Assumption 2001 Contracts:$60  300 = $18,000 First year 40%=20% in 2001 + 20% in 2002 Jan 1 (12 months) and Dec 31 (0 months) =6 month average Feb 1 (11 months) and Dec 1(1 month) =6 month average

9. 6-8 Sales–Even Flow Assumption 2001 Contracts:$60  300 = $18,000 First year 40%=20% in 2001 + 20% in 2002 Jan 1 (12 months) and Dec 31 (0 months) =6 month average Feb 1 (11 months) and Dec 1(1 month) =6 month average Second year 36%=18% in 2002 and 18% in 2003 Third year 24%=12% in 2003 and 12% in 2004

10. 6-9 Revenue Computations by Year Calendar Year 2001 Contracts $60 x 300 = $18,000 2001 $3,600 40% 20023,600 3,240 36% 20033,240 2,160 24% 20042,160 2005 Totals$18,000 } } }

11. 6-10 Revenue Computations by Year Calendar Year 2001 Contracts2002 Contracts $60 x 300 = $18,000$60 x 350 = $21,000 2001 $3,600 40% 20023,600 3,240 36% $4,200 40% 20033,2404,200 2,160 24% 3,780 36% 20042,1603,780 2,520 24% 20052,520 Totals$18,000$21,000 } } } } } }

12. 6-11 Revenue Computations by Year Calendar Year 2001 Contracts2002 ContractsCalendar Year Totals $60 x 300 = $18,000$60 x 350 = $21,000 2001 $3,600 40% 20023,600 $11,040 3,240 36% $4,200 40% 20033,2404,200 $13,380 2,160 24% 3,780 36% 20042,1603,780 $8,460 2,520 24% 20052,520 $2,520 Totals$18,000$21,000$39,000 } } } } } }

13. 6-12 2001 Journal Entries Cash……………………………………………………….18,000 Unearned Revenue From Service Contracts…….18,000 To record cash received from sale of service contracts: 300  $60 = $18,000. Unearned Revenue From Service Contracts……….3,600 Revenue From Service Contracts………………….3,600 To record estimated revenue earned from service contracts: (1/2 .40)  $18,000 = $3,600. Cost of Servicing Television Contracts………………3,350 Cash, Inventory, etc.…………………………………3,350 To record repairs actually made during the year.

14. 6-13 2002 Journal Entries Cash……………………………………………………….21,000 Unearned Revenue From Service Contracts…….21,000 To record cash received from sale of service contracts: 350  $60 = $21,000. Unearned Revenue From Service Contracts……….11,040 Revenue From Service Contracts………………….11,040 To record estimated revenue earned from service contracts.

15. 6-14 2002 Profit on Service Contracts Total revenue from service contracts in 2002……………………$11,040 Total actual expenses relating to service contracts……………9,630 Profit from service contracts in 2002………………………………$1,410

16. 6-15 End of Problem