The product is under warranty so there is no charge to the customer for this service. The expense recognized below is matched with the Year Two revenue recognized above. Many companies utilize such programs on an ongoing basis so that data from previous offers will be available to help determine the amount of the expected loss.
- The company needs to debit warranty expenses and credit prepaid expenses.
- On December 31, we have made a total sales of $500,000 from 1,000 units of products sold during the year.
- Because the corporation has a duty that begins when the product is sold, that obligation establishes a liability when the product is sold.
- And the balance in the warranty liability account will be reduced when there is a warranty claim from the customer.
- To understand what we mean by “warranty liability,” first recall the last time you bought something with a warranty on it.
- There is no income statement impact when the warranty claim is paid.
In this journal entry, both total expenses on the income statement and total liabilities on the balance sheet increase by the same amount. Even though it may make our accounting record look worse, it is usually still necessary to make this journal entry in order to comply with the accounting rule. If this journal entry is not made in the January period, both total liabilities on the balance sheet and costs on the income statement will be underestimated by $8,000.
ASC 450 Contingencies: Warranty Liability Transaction Explained with Journal Entries
Provision for warranty is the liability account on the balance sheet and it will be reversed when the actual warranty incurs. Company ABC sells smartphones to customers with a warranty over one year from the purchasing date. In addition to a normal warranty, company also sells the extended warranty which costs $ 120 per year. A vendor or a manufacturing company uses a warranty as a marketing tool to promote and sell its product by providing its customers a sense of support and security. And due to this reason, the expected warranty claim rate is higher than that of other toy cars. Furthermore, no other companies in the industry sell plastic cars, so there is no information available for comparison.
The debit to the provision for warranties account reduces this liability balance, reflecting a reduction in anticipated future warranty claims. At the same time, the credit of the bank account mirrors the money paid back to the customer. In some cases, where no warranty is offered, the company offers a separate maintenance contract. In such a situation, the certain portion of the revenue representing the expected warranty expense over the lifetime of the product is deferred.
And for this plastic toy car, company A applies a high 3% warranty claim rate based on an accrual-based accounting system. Historically, the warranty cost has been 1% of revenue, and company A records warranty expenses based on that information. However, the company developed a plastic car that is less durable than metal toys. The toy can undergo more breakage or if it gets under a heavy load.
How to Account for Warranty?
In other words, the warranty liability will be settled when the company reimburses or repairs defective or damaged products for customers. In this case, the product warranty is a type of contingent liability that the company needs to make provision for. Some warranties top 15 free and open source restaurant management software come default with the product and some are offered as an add-on purchase to extend the warranty period. Purchasing an extended warranty can be beneficial to customers in the long run, as it usually covers any repairs that may become necessary during its length.
Assurance-Type Warranties
Based on past experience, the average cost of the repairs over the warranty period is estimated to be 8% of the sale price. A provision for the warranties is credited, which goes under the liabilities in the balance sheet. The Khai Ventures would debit warranty expense and credit accumulated warranty, which is a liability on the balance sheet, to record the liability. The goal of this is to record the warranty cost while the revenue is recognized. Consider the company XYZ Ltd. has sold 15 products for $150,000 during September, including a five-year warranty for repairs. Based on experience, the average cost of the repairs over the warranty period is estimated to be 10% of the sale price.
For instance, you will often find on the warranty card for a mobile warranty that the warranty cannot be claimed if the device has been exposed to water. A warranty is the promise of the manufacturer or vendor to the buyer; therefore, it will be an expense for the company if a warranty is claimed. For example, companies usually have past data that show how many defective products are presented among thousands of products sold each year. Of course, new companies can use the available industry data for estimation and make any adjustments based on their own business.
That brings us to the end of this article, which looked at creating the journal entry for recognising a warranty expense. We also looked at the different types of journal entries that would be made depending on whether a warranty claim is settled through a full refund, replacement or repair. So now, it is more apparent that a warranty expense comes from the warranty provision. The debit entry brings to account the expense or anticipated outflow of economic benefits for the year. While the credit creates the liability account, reflecting the estimated debt the company thinks it has at present.
Implied Warranty of fitness
However, our provision for warranties expense isn’t used in this way. A provision account will appear in the balance sheet under the liabilities section, similar to a regular liability account. At the end of the year when Wandy claims the warranty, liability for warranty expense will be debited and spare parts account will be credited. In case the seller company promises both assurance and service type warranties but cannot record them separately, it will be considered as a single performance obligation.
In addition, the manufacture also sells the extended warranty after the end of normal warranty. Customer needs to pay $ 1,200 per year to receive the cost of repair over a certain condition. On 01 Jan 202x+1, XYZ decide to purchase this additional warranty for one year after the normal warranty ended. The closing balance of the warranty payable as at 31 March 2013 i.e. the end of first quarter would be $30,000 ($40,000 minus $10,000). Actual sales in next quarter will increase the liability balance and actual claims will reduce the balance.
Example of Warranty Accounting
The debit impact of the transaction is a recording of the warranty expense in the financial statement, which leads to a reduction in the accounting profit. However, it does not impact the taxable income as the provision is not taxed allowable expenses. Sellers also provide a service agreement that covers maintenance, repairs, and service for products. These additional warranties give the buyer further assurance about the service and maintenance of the product.
Let’s look at an example to see how a company would estimate and record warranty expense. And this journal entry of honored warranty contracts on 45 products will decrease both total assets and total liabilities on the balance sheet by $2,700 as of 2022. This journal entry will increase both total expenses on the income statement and total liabilities on the balance sheet by the same amount of $3,000 as of 2022.
