If a product requires repair or replacement and the issue with the product is covered under a warranty, the policy requires that the company incur this expense. Generally accepted accounting principles require that this warranty expense be matched with revenues received for the sale of the warrantied product. In order to do so, the company estimates future warranty expenses, recognizes the estimated warranty expenses in the period of the sale, and amortizes the expense to reflect actual warrantied repair costs over the life of the warranty.
Things You'll Need
- Warranty repairs history
- Product warranties
- Sales records
Examine the product's warranty repairs and replacement history to determine if a contingent liability should be recorded. A product warranty is a contingent liability if your company's history of warranty repairs and replacements indicates that repairs to and replacement of products under warranty are probable and if you can estimate the current period's warranty costs based on current product warranties and prior warranty repairs and replacements.
Estimate the number of units that'll be returned or repaired under warranty based on your company's prior warranty experience. For example, assume you sold 100 stoves in the prior accounting period. Also assume that no units were replaced, and 10 units required repairs during this same period. Therefore, you can estimate the percentage of units to be repaired under warranty for the current accounting period by dividing 10 by 100 to equal 10 percent.
Calculate the historic average warrantied repair cost. Review your company's warranty repair records to determine both the number of units repaired and the total cost of the repairs. Divide the total cost of warranty repairs by the number of units repaired to obtain the historic average unit repair cost. For example, assume 10 units were repaired and the total cost of warranty repairs was $5,000. The historic average repair cost per unit is equal to $5,000 divided by 10 or $500 per unit.
Calculate the estimated warranty expense. Multiply the estimated percentage of units that'll be returned or repaired under warranty by the number of units sold to determine the number of units that'll probably require warrantied repairs. Multiply this number of units by the average cost to repair each unit to find the estimated warranty liability. For example, assume your company sells 200 warrantied units. Assume that you expect 10 percent of the units will require repairs and that the average repair cost per unit is $500. Multiply 200 units by 10 percent to equal 20 units that'll probably require repairs. Multiply 20 units by the $500 average per unit repair cost to determine the estimated warranty liability of $10,000.
Record the warranty expense in a journal entry. Enter a debit to warranty expense and a credit to estimated warranty liability in the amount of $10,000.
Reduce the estimated warranty liability by actual warrantied repairs expense. For example, assume actual warrantied repairs in the amount of $5,000. In this instance, debit estimated warranty liability and credit cash in the amount of $5,000 to record the amortized warranty expense.