Effect of warranties on income and cash flow
To support herself while attending school, Ellen Abba sold stereo systems to other students. During the first year of operation, she sold systems that had cost her $120,000 cash for $226,000 cash. She provided her customers with a one-year warranty against defects in parts. Based
on industry standards, she estimated that warranty claims would amount to 5 percent of sales. During the year she paid $920 cash to replace a defective tuner.
Required
a.Prepare an income statement and a statement of cash flows for Abba’s first year of operation.
b. Explain the difference between net income and the amount of cash flow from operating activities.
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