YellowCard Company manufactures accessories for iPods. It had the following selected transactions during 2012.
1. YellowCard provides a 2-year warranty on its docking stations, which it began selling in 2012. During 2012, YellowCard spent $6,000 servicing warranty claims. At year-end, Yellow- Card estimates that an additional $45,000 will be spent in the future to service warranties related to 2012 sales.
2. YellowCard has a $200,000 loan outstanding from First Trust Corp. The loan is set to mature on February 28, 2013. For several years, First Trust has agreed to extend the loan, as long as YellowCard makes all its quarterly interest payments (interest is due on the last days of each February, May, August, and November) and maintains an acid-test ratio (also called “quick ratio”) of at least 1.25. First Trust has provided YellowCard a “commitment letter” indicating that First Trust will extend the loan another 12 months, providing YellowCard makes the interest payment due on March 31.
3. During 2011, YellowCard constructed a small manufacturing facility specifically to manufacture one particular accessory. YellowCard paid the construction contractor $5,000,000 cash (which was the total contract price) and placed the facility into service on January 1, 2012. Because of technological change, YellowCard anticipates that the manufacturing facility will be useful for no more than 10 years. The local government where the facility is located required that, at the end of the 10-year period, YellowCard remediate the facility so that it can be used as a community center. YellowCard estimates the cost of remediation to be $500,000.
Accounting
Prepare all 2012 journal entries relating to (a) YellowCard’s warranties, (b) YellowCard’s loan from First Trust Corp., and (c) the new manufacturing facility YellowCard opened on January 1, 2012.
Analysis
Describe how the transactions above affect ratios that might be used to assess YellowCard’s liquidity. How important is the commitment letter that YellowCard has from First Trust Corp. to these ratios?
Principles
YellowCard is contemplating offering an extended warranty. If customers pay an additional $50 at the time of product purchase, YellowCard would extend the warranty an additional two years. Would the extended warranty meet the definition of a liability under current generally accepted accounting principles? Briefly explain?