Accounting for standard and extended warranties Accounting Guide

Accounting For Product Warranties

Let’s look at an example of accounting for standard warranties. Company ABC has been selling gadget XYZ and has sufficient information to estimate warranty expenses based on historical claims data. Standard warranties cover defects in gadgets for one year after gadgets are sold. The company knows that, on average, for every $100,000 of gadgets XYZ sold , there will eventually be approximately $5,000 of warranty claims related to the sold gadgets. The gross margin on the products is $50% (so, $100,000 worth of gadgets has a cost of goods sold of $50,000).

  • Periodically, the credit balance in the Warranty Liability account is reviewed to be certain that the estimated amounts were reasonable.
  • If the warranty period ends, you would need to make an adjustment to decrease the warranty liability and record revenue for the liability not incurred.
  • Thus, the $50 received for the extended warranty is initially recorded as “unearned revenue.” This balance is a liability because the company owes a specified service to the customer.
  • That expected cost is recorded as a liability on its balance sheet and as an expense on its income statement.

If the company charged $20 for a 2 warranty, that $20 would be collected at the time of sale. The warranty would then be recognized as revenue evenly over the 2 year period. Warranties are somewhat easier to account for than is a product recall. Product recalls usually occur after significant attention has been raised regarding a warranty issue. Warranties are accounted for under GAAP by making two separate entries, one a debit and the other a credit for the same amount.

Recording Transactions Related to Product Warranties

It can replace the item with an item from inventory, therefore decreasing inventory. The company could repair the product using parts from inventory and outside labor or inside labor . Always record the replacement or repair at cost, not at the retail value of the item or parts.

  • Accounting for warranty impacts the balance sheet and income statement.
  • The Structured Query Language comprises several different data types that allow it to store different types of information…
  • The company uses the following journal entry for the transaction.
  • Identify the accounting principle applicable to the following situation.
  • Note that the expected future cost to repair or replace is matched with the sales revenue in the period of the sale.

When the cash outflow occurs, the debit is to accrued warranty and the credit is to cash. There is no income statement impact when the warranty claim is paid. Product warranties present manufacturers with a bit of a conundrum. The warranties offered on a product are a part of what the customer purchases when he decides to buy the product in the first place. This means that the manufacturer is actually responsible for the product for the length of the warranty.

2 Recognition of warranty-related costs absorbed by manufacturer

In accounting jargon, the assurance-type warranty is an example of a contingent that is both probable and can be estimated. Therefore, a company must record in the period of the sale the estimated cost of repairing or replacing the product during the Accounting For Product Warranties warranty period. That expected cost is recorded as a liability on its balance sheet and as an expense on its income statement. Note that the expected future cost to repair or replace is matched with the sales revenue in the period of the sale.

How do you account for product warranties?

  1. Find the total number of products sold.
  2. Determine the percentage of defective products.
  3. Calculate the number of products needing replacement.
  4. Evaluate the cost of product replacement.
  5. Estimate the total warranty expense.

Such differences are considered as part of our estimation process for future recalls and other safety measures. The “expected liability for the cost of recalls and other safety measures” are calculated by multiplying the “sales unit” by the “expected average repair cost per unit”. The “expected average repair cost per unit” is calculated based on dividing the “accumulated amount of repair cost paid per unit” by the “pattern of payment occurrences”. The “pattern of payment occurrence” represents a ratio that shows the measure of payment occurrence over 10 years based on actual payments with regard to units sold within 10 years. Prepare any necessary adjusting entries at December 31, 2017, for Piper Company’s year-end financial statements for each of the following separate transactions and events. Assume those costs involve replacements taken out of inventory, with no cash involved.

Financial Performance

Let’s look at an example to see how a company would estimate and record warranty expense. Information available before the financial statements are issued or are available to be issued… Indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements…

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