1 Chapter 3 – Warranty Liability

Marx Yuri Jayme

Warranty
It involves significant cost on the part of the entity of the produce sold prove to be defective in the future within the
specified period of time.
Recognition of Warranty Provision

PAS 37, paragraph 14, provides that a provision shall be recognized as a liability in the financial statements under the
following conditions:

• The entity has a Present Obligation, legal or constructive as a result of past event.
• It is probable that an outflow of resources embodying economic benefits would be required to settle the
obligation.
• The amount of the obligation can be measured reliably.

Past Event

It is referred to the obligating event that must have been occurred. The obligating event in this case is the sale of the
product which gives rise to a constructive obligation.

Probable Outflow Resources

The warranty results in an outflow of resources embodying economic benefit in settlement. It is probable that there will
be some claims against the warranty.

Reliable Estimate

The amount recognized as the warranty provision should be the best estimate of the expenditure to settle the present
obligation. If no reliable estimate can be made, no warranty liability is recognized.

Accounting for Warranty

There are 2 approaches in recording the warranty expense:

1. Accrual Approach

2. Expense as incurred approach

Accrual Approach – it properly matches cost with revenue.

The estimated warranty cost is recorded:

Warranty Expense xxxx
Estimated Warranty Liability xxxx
The actual warranty cost is subsequently incurred and paid:
Estimated Warranty Liability xxxx
Cash xxxx
At a certain date, the estimated amount of warranties are reviewed to check the accuracy and reasonableness.
The difference between the estimate and actual cost is a change in estimate therefore treated currently or
prospectively.
If actual cost exceeds the estimate:
Warranty Expense xxxx
Estimated Warranty Liability xxxx
If actual cost is less than the estimate:
Estimated Warranty Liability xxxx
Warranty Expense xxxx

Illustration: An entity sells 1,000 units of TV sets at 9,000 php each for cash. Each TV set is under a one-year warranty.
The entity has estimated from past experience that warranty cost will probably average 500php per unit and that only
60% of the units sold will be returned for repair. The entity incurs 180,000 php for repairs during the year.
2 Chapter 3 – Warranty Liability
Marx Yuri Jayme

Journal Entries:

Sales (1,000 units * 9,000 Php) 9,000,000

Cash 9,000,000
To record the sales.

Warranty Expense (1,000 * 60% * 500) 300,000

Estimated Warranty Liability 300,000
To record the estimated Warranty Cost.

Estimated Warranty Liability 180,000

Cash 180,000
To record the actual warranty cost incurred and paid.

Estimated Warranty Liability (300,000 – 180,000) 120,000

Warranty Expense 120,000
To record the difference between actual and estimated warranty cost.

The 120,000 Php Estimated Warranty Liability will be reported in the Statement of Financial Position as Current
Liability.
The 300,000 Php Warranty Expense will be reported in the Income Statement for the year ended.

Expense as Incurred Approach

It is the approach of expensing warranty cost only when it is incurred. It is the basis of expediency when warranty cost is
not very substantial or when the warranty period is relatively short.

Entry: Warranty Expense 180,000

Cash 180,000

Another Illustration: 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 warranty
cost as a percentage of sales as follows:

1st year of Warranty 4%

2nd year of Warranty 10%
2020 2021
Sales 5,000,000 6,000,000
Actual warranty repairs 140,000 300,000
Journal Entries

2020

Cash 5,000,000
Sales 5,000,000
To record the sales.
Warranty Expense (5,000,000 *14%) 700,000
Estimated Warranty Liability 700,000
To record the estimated warranty cost.
Estimated Warranty Liability 140,000
Warranty Expense 140,000
To record the actual warranty cost.
Estimated Warranty Liability 560,000
Warranty Expense 560,000
To record the difference between actual and estimated warranty costs.
2021
Cash 6,000,000
Sales 6,000,000
To record the sales.
Warranty Expense (6,000,000 * 14%) 840,000
Estimated Warranty Liability 840,000
To record the estimated warranty cost.
Estimated Warranty Liability 300,000
Warranty Expense 300,000
To record the actual warranty cost.
3 Chapter 3 – Warranty Liability
Marx Yuri Jayme

Estimated Warranty Liability 540,000

Warranty Expense 540,000
To record the difference between actual and estimated warranty costs.
As of December 31, 2021 the estimated warranty liability is 1,100,000.
Estimated Warranty Liability – 2020 560,000
Estimated Warranty Liability – 2021 540,000
Estimated Warranty Liability – December 31, 2021 1,100,000
Testing the accuracy of warranty liability
On December 31,2021 the estimated warranty liability account may be analyzed based on the 4% and 10% estimate to
determine whether the actual warranty cost approximate the estimate.
Sales Made Evenly (Figures and Following Computations are simplified)

December 31, 2020

January 1, 2020 July 1, 2020 / January 1, 2021 July 1, 2021 December
2,500,000 2,500,000 3,000,000 3,000,000 31, 2021

Date Sales First Year Warranty (4%) Second Year Warranty (10%)

01/01/2020 2,500,000 0 0

07/01/2020 2,500,000 0 125,000 (2.5M * ½ * 10%)

01/01/2021 3,000,000 0 300,000 (3M *10%)

07/01/2021 3,000,000 60,000 (3M * ½ * 4%) 300,000 (3M * 10%)

Estimated Warranty Liability – December 31, 2021

(125,000 + 300,000 + 60,000 + 300,000) 785,000
Estimated Warranty per book (1,100,000)
Decrease in Warranty Liability (315,000)

The decrease in warranty liability is an adjustment of warranty expense of 2021.

Estimated Warranty Liability 315,000

Warranty Expense 315,000

Sales of Warranty
Sometimes warranty is sold separately from the product sold. The seller may offer an extended warranty but with
additional costs. I such case, the sale of extended warranty is recorded separately from the product with usual warranty.
The amount received from the sale of the extended warranty is recognized as deferred revenue and subsequently
amortized using straight line over the life of the warranty contract.
If costs are expected to be incurred in performing services under the extended warranty contract, revenue is recognized
in proportion to the cost to be incurred annually.

Illustration: An entity sold a product for 3,000,000 Php. The regular warranty period for the product is 3 years. The
entity sold an additional warranty of two years at a cost of 60,000.

The sale is recorded as:

Cash 3,060,000
Sales 3,000,000
Unearned Warranty Revenue 60,000
The unearned warranty starts only after the expiration of the regular warranty.

Unearned Warranty Revenue 30,000

Warranty Revenue 30,000

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