Background Information:

Most if not all automobiles and trucks sold are subject to some kind of manufacturer warranty, which covers manufacturing defects in factory-supplied materials or factory workmanship. According to recent estimates, global warranty spending in the automotive industry alone surpasses $25 billion annually.

Warranty expense is recognized in the same period as the sales for the products that were sold. Warranty costs can be wildly unpredictable, and thus, GAAP allows warranty issuers to make reasonable estimates of the costs of meeting product warranties. A company may determine the historical percentage of warranty expense to sales for the same types of vehicles, apply the same percentage to the sales for the current accounting period to derive the warranty expense to be accrued. If there's no change in product quality, the percentage rate should remain relatively unchanged and then warranty accruals should remain proportional to sales. No sale, no warranty.

Many car manufacturers sell extended warranty. For example, Toyota allows car owners to buy extended warranty up to eight years or 125,000 miles. How should we recognize these transactions and how do these transactions affect our warranty liabilities or claim amounts? ( 5 points)