Ravens Machinery Co. manufactures equipment to a very high standard of quality; however, it must still provide a warranty for each unit sold, and there are instances where the machines do require repair after they have been put into use. Ravens started in business in 2020, and as the controller, you are trying to determine whether to use the assurance-type or service-type warranty approach to measure the warranty obligation. You would like to show the company president how this choice would affect the financial statements for 2020 and advise him of the better choice. Keep in mind that the service type approach is consistent with IFRS and that there are plans to take Ravens public in a few years.

You have determined that sales on account for the year were 1,000 units, with a selling price of $3,000 each. Ignore any cost of goods sold. The warranty is for two years, and the estimated warranty cost averages $200 per machine. The actual costs of servicing warranties for the year were $105,000. You have done some research and determined that, if the service-type approach were to be used, the portion of revenue allocated to the warranty portion of the sale would be $350 per unit. Because the costs of servicing warranties are not incurred evenly, warranty revenues are recognized based on the proportion of costs incurred out of the total estimated costs.

Instructions

1. For both the assurance-type and the service-type approaches, prepare the necessary journal entries to record all the transactions described, and determine the warranty liability and expense amounts for 2020. Round all values to the nearest dollar. Payments for completed warranty repairs are paid in cash.
2. What are the advantages and the disadvantages of the two choices? (4 marks) What do you think is the best choice in this situation? Why?