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