Warranty is a liability account. Warranty is a permanent account meaning at the end of the reporting period, the liability is carried over to the next period. It is a promise of a seller to a buyer to make good on a deficiency of quantity, quality, or performance in a product. This is a way for the seller to assure the buyer just in case there is a defect on the product the buyer can claim the promise agreement. This kind of provision has different expirations and policies. Assuming the claim is valid, the seller may either repair or replace the item. Just in case the product is inadequate then the seller will add to deliver the right quantity. It is attractive to the buyer because it assures them of the deficiency of quantity, quality of performance of a product.
Accounting for Warranty
1.) Expense as incurred approach
This method is not following Generally Accepted Accounting Principles (GAAP). It is considered and allowed to use this method, especially for small businesses, because in reality, the volumes of transactions are minimal. Another term for this is cash method. Because the recording of expense is based on actual expense.
2.) Accrual approach
The accrual method is following GAAP. The assumption in the case that the problem is silent is to use accrual approach. Accrual means recording the expected expense incurred upon sale.
Illustration on expense as incurred approach:
ABC company sells a Sala set with a two-year warranty. The selling price per set is P30,000. The average repair per set is P3,000. The company experience 20% repair in the first year. Moreover, 40% repair in the second year of all the Sala sets sold. The total set sold in 2020 is 500 and 1,000 set in the year 2021. The total payment of warranty in 2020 is P300,000 and P350,000 in 2021.
To record the sale in the year 2020:
Cash P15,000,000
Sales P15,000,000
To record the payment of repair in the year 2020:
Warranty expense P300,000
Cash P300,000
Note: The provision expense is recorded when incurred.
The sales are computed by multiplying the selling price to the number of units sold (P30,000×500=P15,000,000).
To record the sale in the year 2021:
Cash P30,000,000
Sales P30,000,000
To record the payment of repairs in the year 2021:
Warranty expense P350,000
Cash P350,000
Illustration on Accrual approach:
ABC company sells a Sala set with a two-year warranty. The selling price per set is P30,000. The average repair per set is P3,000. The company experience 20% repair in the first year. Moreover, 40% repair in the second year of all the Sala sets sold. The total set sold in 2020 is 500 and 1,000 set in the year 2021. The total payment of warranty in 2020 is P300,000 and P350,000 in 2021.
To record the sale in the year 2020:
Cash P15,000,000
Sales P15,000,000
To record estimated liability in the year 2020:
Warranty expense P900,000
Warranty Liability P900,000
To record payment of repairs in the year 2020:
Warranty liability P300,000
Warranty Expense P300,000
Note: In this approach, the provision liability is recorded on the date of sale. It means that the expected repair based on the company experience is the basis of recording the warranty liability. The sales are computed by multiplying the selling price by the number of units sold (P30,000×1000=P30,000,000). Warranty expense is computed as the number of units sold (500) multiply by the percentage of repair based on experience (20% and 40% = 60%). The product of the number of units and repair percentage is multiplied by the cost of repair per set (P3,000).
500 x 60% x P3,000 = P900,000
To record the sale in the year 2021:
Cash P30,000,000
Sales P30,000,000
To record estimated liability in the year 2021:
Warranty expense P1,800,000
Warranty Liability P1,800,000
To record payment of repairs in the year 2021:
Warranty liability P350,000
Warranty Expense P350,000
Conclusion:
Warranty can be in terms of quantity, quality or performance. It is classified as provision. The expiration and policy vary depending on the items subject for provisions. In addition, it has two methods of recording transactions.
Related Blog: Liabilities and GAAP Principles
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