Reference no: EM132865771

Problem - Warranty Cost Estimate - John Walton is an accountant for ABC Auto Dealers, a large auto dealership in a metropolitan area. ABC sells both new and used cars. New cars are sold with a five-year warranty, the cost of which is carried by the manufacturer. For several years, however, ABC has offered a two-year warranty on used cars. The cost of the warranty is an expense to ABC, and John has been asked by his boss, Mr. Sawyer, to review warranty costs and recommend the amount to accrue on the year-end financial statements.

For the past several years, ABC has recorded as warranty expense 5% of used car sales. John analyzed past repair records and found that repairs, although fluctuating somewhat from year to year, have averaged near the 5% level. John is convinced, however, that 5% is inadequate for the coming year. He bases his judgment on industry reports of increased repair costs and on the fact that several cars that were recently sold on warranty have experienced very high repair costs. John believes that the current year repair accrual will be at least 10%. He discussed the higher expense amount with Mr. Sawyer, who is the controller of ABC.

Mr. Sawyer was not happy with John's decision concerning warranty expense. He reminded John of the need to control expenses during the recent sales downturn. He also reminded John that ABC was seeking a large loan from the bank and that its loan officers might not be happy with recent operating results, especially if ABC began to accrue larger amounts for future estimated amounts such as warranties. Finally, Mr. Sawyer reminded John that most of the employees of ABC, including Mr. Sawyer, were members of the company's profit-sharing plan and would not be happy with the reduced share of profits. Mr. Sawyer thanked John for his judgment concerning warranty cost but told him that the accrual for the current year would remain at 5%.

John left the meeting with Mr. Sawyer feeling somewhat frustrated. He was convinced that his judgment concerning the warranty costs was correct. He knew that the owner of ABC would be visiting the office next week and wondered whether he should discuss the matter with him at that time. John also had met one of the loan officers from the bank several times and considered calling her to discuss his concern about the warranty expense amount on the year-end statements.

Required - Discuss the courses of action available to John. What should John do concerning his judgment of warranty costs?