Recording Warranty Expenses and Liabilities

The product is covered by a warranty that extends until the end of Year Three. No claims are made in Year One but similar programs in the past have resulted in repairs being made to 3 percent of the refrigerator at an average cost of $90. Thus, this warranty is expected to cost a total of $27,000 (ten thousand units × 3 percent or three hundred claims × $90 each). Immediate recognition is appropriate because the loss is both probable and subject to reasonable estimation. What will be the journal entry when we receive the faulty products from the customer? Or we we have to value the faulty product at the point of return and then recorder into the inventory as damage material.

  • On the other hand, a service-based Warranty is when a business promises to perform certain additional services.
  • If the cost of this type of embedded warranty eventually proves to be incorrect, the correction is made when discovered.
  • You have to assess each warranty, because some warranties are separate performance obligations and the other one are not.
  • The warranty that we give to the customer is a type of contingent liability that we usually need to make the provision for.
  • The product warranty they provide is an agreement in which maintenance is provided by them for a specific period of time and this warranty is included in the price of their products.

However, once the company has reimbursed or repaired the customer’s defective or damaged products under Warranty, the liability for a warranty expense will then be settled. 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. As a result, an obligation clause is incorporated into the issuer’s contract.

How to Record Warranty Liability Journal Entry?

By giving different types of warranties, the brands and manufacturers convey a message that their products are up to the mark, and they are so confident about it that they won’t mind giving a replacement. If you’ve ever needed to use your warranty, you know what a relief it is—and certainly worth the cost of having spent extra money on it when you bought your product. When companies offer warranties, they’re also making themselves liable for any future damages incurred by their products. When a corporation sells a product with a warranty, the warranty should be paid for a purchase. There is no right or incorrect method for calculating the possible responsibility of providing a warranty.

  • In the first year, he will receive a free warranty from the company.
  • If the product is new or used, the Implied Warranty of merchantability applies.
  • It is another business transaction that needs to account separately.
  • The prepaid expense must be recorded as an expense based on the term of the warranty.
  • Before you start accounting for warranties, you need to determine what type of warranty you have.
  • The assurance warranty is when the business gives a general warranty of the product.

After this period has expired, customers will have to pay a fee if they want to continue receiving phone support regarding the equipment. And there are some other things to consider too based on the nature of the product and service you sell. Whenever a person buys a product, there are a lot of thoughts going on in his mind; for instance product design, durability, specifications, etc. However, the biggest concerns of a consumer while buying a product are its durability, security, and longevity.

Recording Warranty Expenses and Liabilities

Also, the company honored warranty contracts on 45 products at the total cost of $2,700 during 2022. We have discussed all the aspects of warranties, types, nature, accounting treatment, and the perspective of buyer and seller. For the business entities purchasing the products with warranties, one of the most staggering questions is whether to treat the warranty as an operating expense or add it to the asset’s value.

Types of Warranty

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. Later, when the company provides the repairs under warranty for its customers, it can make the journal entry by the debit of warranty payable and the credit of repair parts. 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. Company ABC has sold the car to customers for $ 80,000 on credit, it is attached with one year warranty.

Example# 1: Assurance Type Warranties

And with that, the warranty expense is recognized in the same period as the sales of the products. All sale-related costs and expenses are identified and recognized in the same period to satisfy the accounting concept called the matching principle. By accepting money for an extended warranty, the seller agrees to provide services in the future. The revenue is not earned until the earning process is substantially complete in the future. 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. As indicated previously, liabilities do not always represent future cash payments.

If the company can reasonably estimate the amount of warranty claims likely to arise under the policy, it should accrue an expense that reflects the cost of these anticipated claims. In this journal entry, the inventory account represents either the repair parts inventory or the product inventory itself. In other words, the company may need to repair the damaged product or replace the default goods itself.

What is the journal entry for recording warranty claims paid?

Moreover, they do not have the option to purchase products without normal warranty. The normal warranty automatically attaches to a new product from the factory to ensure that the product go through quality control. 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. The extended warranty will count from the end of normal warranty. In order to receive this warranty, customers require to pay in advance, and service will provide a base on the contractual period.