Petula's Business Sells Heat Pumps Which Have a One-Year Warranty

question 75

Essay

Petula's business sells heat pumps which have a one-year warranty. Based on historical data, the warranty costs amount to 11% of sales. During 2018, heat pump sales are $400,000. Actual warranty expenses paid in 2018 are $40,000.
a. Determine the amount of the warranty expense deduction for 2018 if Petula's business uses the accrual method.
b. How would your answer change if Petula used the cash method for extended warranties and the purchasers paid $25,000 for the warranties which covered the second and third years of ownership?

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Definitions:

Premium Amortization

The gradual reduction of the premium paid above the face value of a bond, allocated over the life of the bond.

Bond Premium

The difference between the selling price of a bond and the bond’s face value when the bond is sold for more than par.

Effective-Interest Amortization

A method of amortizing a bond discount or bond premium that reflects the effective interest rate a company pays bondholders over the life of a bond.

Coupon Interest Rate

The annual interest rate paid by a bond expressed as a percentage of its face value.