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Future CPA
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| Posted: 26 Nov 2009 at 14:34 | IP Logged
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Vadis Co. sells appliances that include a three-year warranty. Service calls under the warranty are performed by an independent mechanic under a contract with Vadis. Based on experience, warranty costs are estimated at $30 for each machine sold. When should Vadis recognize these warranty costs?
Correct answer: When Machines are sold.
My answer: Evenly over the life of the warranty.
I was under the impression that we should level out the costs over the period. For example, in leasing, when we pay a commision to the realtor for a lease, we don't expense the entire thing immediately, rather amortize over the life. So I thought it was a similar concept here. Because we really haven't incurred the cost yet, can someone tell the the logic to why we match the expense with the revenue?
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Zeratul
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| Posted: 26 Nov 2009 at 14:51 | IP Logged
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The reason why we MATCH the expense with the revenue is because of the MATCHing principle. It's a similar concept to ADA for recievables. Technically you haven't incurred the expense yet, but the liability is probable and reasonably estimatable, so you recognize it, along with the expense. Generally, we would prefer to recognize the warranty expense along with the related revenues, since this would lead to more meaningful earnings than if the revenues were in this period and the related warranty expense was spread over the next few periods.
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Future CPA
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| Posted: 26 Nov 2009 at 14:54 | IP Logged
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So we should treat the warranty expense like COGS? We record sales and COGS in the same period.
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My inspiration: "O mankind! We have created you male & female, & have made you nations & tribes that ye may know one another. The noblest of you is the best in conduct."-Quran
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Zeratul
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| Posted: 26 Nov 2009 at 21:34 | IP Logged
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I'd compare it more to ADA, but the concept is right. Basically you estimate the warranty claims you expect to be redeemed and expense the estimated warranty expense along with the related sales.
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Future CPA
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| Posted: 26 Nov 2009 at 21:41 | IP Logged
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Sounds good. If I get stuck again, I'll treat it more like an ADA. Thanks!!
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My inspiration: "O mankind! We have created you male & female, & have made you nations & tribes that ye may know one another. The noblest of you is the best in conduct."-Quran
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Topic: Warranty costs
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