How to Account for Warranty Revenue
A company that sells products, like electronics and appliances, may offer customers a warranty at the point of sale. A warranty means that if something breaks or malfunctions, the customer can bring it back to have it repaired. When a company sells a warranty, it must account for the possibility that some of the goods will be in need of repairs. Many companies go off prior-year warranty claims to determine a percentage of sales that will be returned under warranty, as explained by the Cliffs Notes website. When a company has warranty revenue, it must account for the obligation to make warranty repairs.
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Instructions
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Warranty Revenue
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1
Write down the date when the company received payment for the warranty. The day and month of the warranty sale must appear in the general journal.
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2
Debit the company’s cash account to indicate the amount the customer paid for the warranty. Let’s assume the customer paid $250 for a one-year extended warranty on a vacuum cleaner. This transaction indicates the company’s cash account has increased by $250.
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3
Credit the warranty revenue account. The credit amount must equal the debit amount because credits must always equal debits. The credit for warranty revenue illustrates an increase in warranty sales. This transaction shows the company generated $250 in warranty revenue.
Warranty Obligation
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4
Calculate the company’s estimated warranty liability. Let’s say a company estimates that 2 percent of the 5,000 vacuum cleaners sold will be returned for warranty repairs. Assume it costs the company $75 to repair each vacuum cleaner. In this scenario, the company-estimated warranty liability equals $7,500 because 2 percent of 5,000 equals 100. This means the company expects 100 units to require warranty repairs. At $75 to repair each unit, the company arrives at $7,500 for estimated warranty expense.
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5
Write down the day and month when the company determines its estimated warranty expense.
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6
Debit the warranty expense account for the appropriate amount. This increases the company’s expense, which decreases the revenue generated by the business. Warranty expense appears on a company’s income statement. In this scenario, the company must debit warranty expense for $7,500.
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7
Credit warranties payable for the applicable amount. The credit to warranties payable must equal the debit to warranty expense. This means the company will credit warranties payable for $7,500 to illustrate an increase in the company’s obligations.
Warranty Claims
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8
Draft the date of the warranty return. Indicate the day and month when a customer returned an item for a warranty repair.
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9
Debit warranties payable for the applicable amount. Let’s assume a customer returns two vacuum cleaners for warranty repairs. Since it costs $75 per unit to make repairs, the company must debit warranties payable for $150. This decreases the company’s liability and illustrates a $150 reduction in the warranties payable account.
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10
Credit the cash account for the applicable amount. This illustrates a reduction in the company’s cash account. The cash account credit must be the same as the debit to warranties payable.
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