Accounting for Product Warranties

If the cost of this type of embedded warranty eventually proves to be incorrect, the correction is made when discovered. Companies also sell extended warranties, primarily as a means of increasing profits. These warranties are recorded initially as liabilities and are reclassified to revenue over the time of the obligation.

• The product is covered by a warranty that extends until the end of Year Three.
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• Or we we have to value the faulty product at the point of return and then recorder into the inventory as damage material.

Before that, we should look at what a warranty is, the different types of warranties, and when a company accounts for warranty expenses. Each gyro scooter comes with a one-year warranty against any manufacturing defects. The company refers to the previous five years of operations and estimates that 4% (defect rate) of the gyro scooters sold in the current year will be returned because of a defect.

Types of Warranty

The warranty expense occurs because the sale took place. The expense is a cost of the sale and therefore should be matched with the revenue generated by that sale. At the time of the sale, the warranty expenses are debited. A provision for the warranties is credited, which goes under the liabilities in the balance sheet. So, the warranty’s accounting nature is an expense for the entity that will be debited to the company’s accounts at the time of sale against the warranty provision account.

How is the company fulfilling the liability in this case? Water bottles are the product that the company sells. Therefore, we will reduce inventory by the amount that the bottles cost. When we use inventory to fulfill the warranty liability, the value of inventory falls.

What is a warranty?

However, historical trends cannot be followed blindly. Officials still have to be alert for any changes that could impact previous patterns. For example, in bad economic periods, customers are more likely to take the time to complete the paperwork required to receive a cash rebate.

More information is now available, some of which might suggest that $14,000 is no longer the best number to be utilized for the final period of the warranty. The reported figure must be updated to provide a fair presentation of the information that is now available. Accounting For Product Warranties Estimations should be changed at the point that new data provide a clearer vision of future events. 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.

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At the end of Year Two, the warranty payable T-account in the general ledger holds a balance of $14,000 ($27,000 original estimation less $13,000 payout for repairs to date). Because the warranty has not expired, company officials need to evaluate whether this $14,000 liability is still a reasonable estimation of the remaining costs https://kelleysbookkeeping.com/property-plant-and-equipment-pp-e-definition/ to be incurred. This warranty is in effect until the end of Year Three. Assume in the year following the sale (Year Two) that repairs costing $13,000 are made for these customers at no charge. The expense has already been recognized in the year of sale so the payments made by the company serve to reduce the recorded liability.

The revenue is not earned until the earning process is substantially complete in the future. As indicated previously, liabilities do not always represent future cash payments. During the accounting period, Red Co. received warranty claims of $4,000 on its products. When a customer requests a repair or replacement under warranty, the customer files a claim.

There are a number of ways that the company can fulfill a claim. 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 (which would require cash) or inside labor (wages payable). Always record the replacement or repair at cost, not at the retail value of the item or parts. A buyer is entitled to the implied warranty for a specific product at the time of purchase. It is that type of warranty that is exercisable regardless of whether the seller or manufacturer has explicitly expressed the assurance.

But, it is bound with different conditions like warranty can only be claimed if there has been no alteration, repair, changing of any parts with sub-standard substitutes, etc. The warranty is implied by conditions or even implied by law. The buyers can go to the consumer court in case of any violation.