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Module 3: Warranty Liabilities

What is Warranty Liability?

Pertains to the obligation of a selling entity to its customers to provide free repair service or
replacement during a specified period if the products are defective.
This is recognized as a liability because it will involve significant costs on the part of the selling entity
should the products sold prove to be defective in the future within the specified period of time.

When is Warranty Liability recognized?

PAS 37 Par 14: a provision shall be recognized as a liability in the FS under the following
conditions:
(a) Entity has present obligation, legal or constructive, as a result of past event
(b) Probable that an outflow of resources embodying economic benefits would be required to
settle the obligation
(c) The amount of the obligation can be measured reliably.

Legal Obligation is derived from a CONTRACT, LEGISLATION, or OTHER OPERATION OF

LAW.

Constructive Obligation is derived from an entity's actions where:

(a) the Entity has indicated to the other parties that it will accept certain responsibilities by reason
of an established pattern of past practice, published policy, or a sufficiently specific current
statement;
(b) And as a result, the entity has created a valid expectation on the part of other parties that it
will discharge those responsibilities.
● Constructive Obligation exists when the entity from an established pattern of PRACTICE or
stated POLICY has created a valid expectation that it will accept certain responsibilities.

When is the recognition applied?

THE OBLIGATING EVENT which is a PAST EVENT in a warranty is the SALE OF THE PRODUCTS
that constructively gave rise to the obligation.
➔ If there was no sale, then there will be no basis for warranty claims.
➔ If there was a sale, there is a probability that the product may be defective, hence a claim for
warranty arises.

PROBABLE OUTFLOW OF ECONOMIC RESOURCES would come from the probable CLAIMS
FOR PRODUCT DEFECTS against the warranty or guarantee.
➔ There is a corresponding outflow of resources as a result of a warranty claim.

A RELIABLE ESTIMATE IS A PROVISION OF THE BEST ESTIMATE of the expenditure to settle

the present obligation.
➔ An estimated amount MUST BE ESTABLISHED to value the amount of warranty claim; no
estimated amount, no recognition of warranty liability.
➔ WHEN NO RELIABLE ESTIMATE CAN BE MADE, NO WARRANTY LIABILITY SHALL BE
RECOGNIZED.

Accounting for Warranty (two approaches):

(a) Accrual
(b) Expense incurred
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ACCRUAL APPROACH

● Soundest theoretical approach because it properly matches cost with revenues

Pro-forma accounting entries:

a. Record the estimated warranty cost

Warranty Expense xxx

Estimated warranty liability xxx

b. Record actual warranty cost incurred

and paid

Estimated warranty liability xxx

Cash xxx

● ESTIMATE MUST BE REVIEWED at a certain date to determine its reasonableness and

accuracy.
● ACTUAL WARRANTY COST IS ANALYZED to validate the applicability or accuracy of the
original estimate or a change in estimate is necessary.
● ANY DIFFERENCE between an estimate and the actual cost is a CHANGE IN
● ESTIMATE and therefore treated currently or prospectively, if necessary.

Additional pro-forma accounting entries:

Record the difference between the estimate and actual cost:
a. If the actual cost exceeds the estimate,
the difference is charged to warranty
expense

Warranty Expense xxx

Estimated warranty liability xxx

b. If the actual cost is less than the

estimate, adjust the warranty expense

Estimated warranty liability xxx

Warranty Expense xxx

ILLUSTRATION 1

➔ 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.
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Accounting Entries:
(1) To record sales:

Cash 9,000,000

Sales 9,000,000

(2) To set up the estimated liability on the warranty:

Warranty Expense 300,000

Estimated Warranty Liability 300,000

Computations:

Sold units 1,000

Estimated returns 60%

Estimated no. of units to be returned (1,000 * 60%) 600 units

Estimated warranty cost per unit 500 per unit

Estimated warranty cost (600 * 500) 300,000

(3) To record the payment of the actual cost:

Estimated Warranty Liability 180,000

Cash 180,000

FINANCIAL STATEMENT PRESENTATION

Balance Sheet will report Estimated Warranty Liability under the current liability of P120.000.

Estimated warranty liability 300,000

Less: Actual warranty cost paid 180,000

Balance as of end of period 120,000

● If the warranty runs over a period of more than one year, a portion of the estimated warranty liability
shall be reported as a current liability and the remaining portion as a non-current liability.
- Warranty cost expected to be incurred within one year is current and the balance is
noncurrent.

The income statement will report a Warranty Expense of P300,000 for the year.
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EXPENSE AS INCURRED APPROACH

Expensing the warranty cost only WHEN ACTUALLY INCURRED

Applied for expediency when warranty cost is not very substantial or the period covered of
the warranty is relatively for a short period only
In the illustrative problem, the only accounting entry to be made is for the actual warranty
cost

Warranty Expense 180,000

Cash 180,000

ILLUSTRATION 2

➔ 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 past experience, the entity projects an estimated warranty cost as a percentage of sales
as follows:

First year of warranty 4%

Second year of warranty 10%

2020 2021

Sales 5,000,000 6,000,000

Actual warranty repairs 140,000 300,000

Journal Entries:
(1) To record sales:

Cash 5,000,000

Sales 5,000,000

(2) To record estimated warranty expense

Warranty Expense 700,000

Estimated Warranty Liability 700,000

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