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Chapter 3 Warranty Liabilities

1. A warranty is a guarantee that promises to repair or replace defective products within a specified period. Recognizing warranty liabilities follows accounting standards where the liability is probable, measurable, and results from a past transaction. 2. There are two approaches to accounting for warranties - the accrual approach matches repair costs to revenue in the period earned, while the expense-as-incurred approach only records costs when repairs are made. 3. Sample entries record sales, estimate warranty liabilities based on historical rates, and actual repair costs with the difference adjusting estimates or expenses. Extended warranties defer revenue over the contract period.

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282 views6 pages

Chapter 3 Warranty Liabilities

1. A warranty is a guarantee that promises to repair or replace defective products within a specified period. Recognizing warranty liabilities follows accounting standards where the liability is probable, measurable, and results from a past transaction. 2. There are two approaches to accounting for warranties - the accrual approach matches repair costs to revenue in the period earned, while the expense-as-incurred approach only records costs when repairs are made. 3. Sample entries record sales, estimate warranty liabilities based on historical rates, and actual repair costs with the difference adjusting estimates or expenses. Extended warranties defer revenue over the contract period.

Uploaded by

Joana Marie
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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CHAPTER 3 - WARRANTY LIABILITIES

WHAT IS WARRANTY?
- A written guarantee, issued to the purchaser of an article by its
manufacturer, promising to repair or replace it if necessary within
a specified period of time.
- Home appliances are often sold under guarantee or warranty to
provide free repair service or replacement during a specified
period if the products are defective.
- Such policy may involve significant costs on the part of the
entity if the products sold prove to be defective in the future within
the specified period.

RECOGNITION OF WARRANTY
• How to recognize? When it is:
1. Present Obligation as a result of past event
2. Probable (outflow)
3. Measurable (reliably)/Reliable Estimate (Best Estimate)
• Where no reliable estimate can be made, no warranty liability
is recognized.

WARRANTY - ACCOUNTING
How to account?
2 APPROACHES IN ACCOUNTING FOR WARRANTY:
1. Accrual Approach
2. Expense as incurred approach
(Expense outright approach)

1. Accrual Approach
- soundest theoretical support
- matching of cost with revenue
Accounting Entries:
Warranty expense xxx
Estimate Warranty Liability xxx
#
When actual warranty cost is subsequently incurred and paid, the
entry is:
Estimate warranty liability xxx
Cash xxx
#

- At a certain date, the estimate is reviewed to determine its


reasonableness and accuracy. The actual warranty cost is
analyzed to validate the original estimate.
- Any difference between estimate and actual cost is a change in
accounting estimate (treated as currently and prospectively), if
necessary.

If the actual cost exceeds the estimate, the difference is


charged to warranty expense:
Accounting Entries:
Warranty expense xxx
Estimate Warranty Liability xxx
#
If the actual cost is less than the estimate, the difference is an
adjustment to warranty expense as follows:
Estimate warranty liability xxx
Warranty expense xxx
#

WARRANTY EXPENSE
• Reworded in the year of sale (Matching Principle)
• Based on sales
- percentage
- specific cost
Estimated Warranty Liability
Beg. balance xxx
Expense xxx
Less: Actual Repairs (xxx)
Ending Balance (normally credit) xxx

Testing the Accuracy of Warranty Liability


Total Sales x Rate = Warranty Expense
Warranty Expense - Actual Repairs = Warranty Liability

• Sale Made Evenly

Sample Problem:
(Accrual Approach)
- An entity sells 1,000 units of television sets at P9,000 each for
cash. Each television set is under warranty for one year.
- The entity has estimated from past experience that warranty
cost will probably average P500 per unit and that only 60% of the
units sold will be returned for repair.
- The entity incurs P180,000 for repairs during the year.
Entries:
1. To record the sales
Cash P9,000,000
Sales P9,000,000
(P9,000 x 1,000 units)
2. To set up the estimated liability on the warranty:
Warranty expense P300,000
Estimate Warranty Liability P300,000
(1,000 units × P500 per set x 60%)
3. To record the payment of the actual cost:
Estimated warranty liability P180,000
Cash P180,000
• The SFP would report EWL of P120,000 as current liability.
• Income Statement will show P300,000 Warranty expense.
• If the warranty runs over a period of more than 1 year = portion
will be current and the balance is noncurrent.

2. Expense as Incurred Approach


- Expensing the warranty cost only when actually incurred.
- This approach is justified on the basis of expediency when
warranty cost is not very substantial or when the warranty
period is relatively short.
Accounting Entry:
Warranty Expense xxx
Cash xxx

Sample Problem:
- An entity sells refrigerators that carry a 2-year warranty against
defects. The sales and warranty repairs are made evenly
throughout the year.
- Based on the past experience, the entity projects an estimated
projects an estimated warranty cost as a percentage of sales as
follows:
First year of warranty - 4%
Second year of warranty 10%

Journal Entries - 2019


1. To record sales
Cash P5,000,000
Sales P5,000,000
2. To record the warranty expense
Warranty expense P700,000
Estimated warrant liability P700,000
(14% × P5,000,000)
Note that the total warranty expense each is 14% to be
incurred over a 2-year warranty period.
3. To record the actual warranty repairs
Estimated Warranty liability P140,000
Cash P140,000
Journal Entries -2020
1. To record sales
Cash P6,000,000
Sales P6,000,000
2. To record the warranty expense
Warranty expense P840,000
Estimated warrant liability P840,000
(14% × P6,000,000)
3. To record the actual warranty repairs
Estimated Warranty liability P300,000
Cash P300,000
TESTING THE ACCURACY OF WARRANTY LIABILITY
- On December 31, 2020, the estimated warranty liability account
may be analyzed based on the 4% and 10% estimate to
determine whether the actual warranty costs approximate the
estimate.

SALE OF WARRANTY
- A warranty is sometimes sold separately from the product
sold.
- When products are sold, the customers are entitled to the usual
manufacturer's warranty during a certain period.
- However, the seller may offer an "extended warranty" on the
product sold but with additional cost.
- In such a case, the sale of the product with the usual warranty is
recorded separately from the sale of the extended warranty.
- The amount received from the sale of the extended warranty is
recognized initially as deferred revenue and subsequently
amortized using straight line over the life of the warranty
contract.
- However, if costs are expected to be incurred in performing
services under the extended warranty contract, revenue is
recognized is proportion to the costs to be incurred annually.

Accounting Entries:
Cash xxx
Sales xxx
Unearned Warranty Revenue xxx
#
Unearned Warranty Revenue xxx
Warranty Revenue xxx
#

• Amortization begins only after the expiration of regular


warranty period.

Sample Problem:
- An entity sold a product for P3,000,000. The regular warranty
period for the product is two years. The entity sold an additional
warranty of two years at a cost of P60,000.

•The sale is recorded as follows:


Cash P3,060,000
Sales P3,000,000
Unearned warranty revenue P60,000

•The extended warranty contract starts only after the expiration of


the regular two-year warranty period.

•If the costs are incurred evenly, the unearned warranty revenue is
amortized at the end of the third year as follows:
Unearned warranty revenue P30,000
Warranty Revenue P30,000

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