Seagull Designs does not report any warranty costs in its income statement, nor does it report any warranty obligations in its balance sheet. Seagull reports only the following four types of costs and expenses in its income statement:

• Costs of sales

• Sales and marketing

• Research and development

• General and administrative Its sales decreased significantly from 1998 to 1999, at which point they stabilized through 2000. Its balance sheet equation is summarized below:

346 CHAPTER 8 Ethics ASSETS
LIABILITIES SHAREHOLDERS’ EQUITY

$44M $6M $38M Required

a. Assuming Seagull offers warranties to its clients, where are its warranty costs reported on the income statement? Why might they not be separately reported?

b. Suppose Seagull’s warranty costs increased significantly from 1998 to 2000.

Its board must decide whether to recognize warranty obligations of $5 million or $10 million. Show the effects on Seagull’s balance sheet equation (dollars in millions) at the end of 2000 under each of these proposals.