P9-6 Defining and Analyzing Changes in Current Liabilities LO9-1

International Business Machines (IBM) is a leading provider of computer products and services. The company is known for its hardware products but has focused on providing information technology services in recent years. IBM provides standard warranties and extended warranties with the sale of its products. The companys note on significant accounting policies is as follows:

The company offers warranties for its hardware products that generally range up to three years, with the majority being either one or three years. Estimated costs for standard warranty terms are recognized when revenue is recorded for the related product. The company estimates its warranty costs standard to the product based on historical warranty claim experience and estimates of future spending and applies this estimate to the revenue stream for products under warranty. Estimated future costs for warranties applicable to revenue recognized in the current period are charged to cost of sales. The warranty liability is reviewed quarterly to verify that it properly reflects the remaining obligation based on the anticipated expenditures over the balance of the obligation period.

Revenue from extended warranty contracts is initially recorded as deferred income and subsequently recognized on a straight-line basis over the delivery period because the company is providing a service of standing ready to provide services over such term.

Selected information related to warranties provided by IBM follows (in millions of U.S. dollars):

	2018			2017			2016
Net revenues	$	81,591		$	81,139		$	81,919
Standard warranty liability, end of year		158			192			196
Charges incurred during the year		163			205			204
Extended warranty deferred revenue, end of year		573			606			571
Revenue deferred for new extended warranty contracts		260			307			303

Required:

1. Compute the amount of warranty expense for 2017 and 2018. (Enter your answers in millions of dollars.)

2. Prepare journal entries to record both the warranty expense for 2018 and the payments made under the warranty during the year. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field. Enter your answers in millions of dollars.)

3-a. Compute the ratio of the warranty expense to net revenues for the three years. The Standard warranty liability had a balance of $221 at the beginning of 2016. (Round percentage answers to 2 decimal places (i.e., 0.1243 should be entered as 12.43).)

3-b. Has the ratio increased or decreased during the three-year period? (Enter your answers in millions of dollars.)

4. Based on the limited information available about the warranty expense and settlements during these three years, should IBM reduce the ratio of the warranty expense to net sales in future years?

multiple choice

• Yes

• No

5-a. Compute the extended warranty revenue recognized during 2017 and 2018. (Enter your answers in millions of dollars.)

5-b. Prepare the journal entry to record the revenue recognized in 2018. (If no entry is required for a transaction/event, select "No journal entry required" in the first account field. Enter your answers in millions of dollars.)