Warranty is an agreement by the seller of services or goods in order to satisfy a stated period of time deficiencies in the item’s quality or performance. A business may have liabilities that, while quite real, can only be estimated. A company which sells appliances with warranties can incur this kind of liability. In such situations, the company guarantees free repair within a specified period of time in the event of a problem with their product.
The estimate of the probable expense of such repairs may be based on a prior experience. In such cases, the liability for warranties might be a percentage of total sales in a given period. For example, assume Company A sells 200 washing machines in 2017 with one year warranties. Based on past experience, the company exceeds 5% of its washing machines to be defective within the one year warranty period. The average service call is estimated at $25. During 2017, 3 washing machine are repaired at a cost of $70. In 2018, 6 washing machines are repaired at a cost of $130. The entries necessary will be reflected to record expenditures for repairs as well as entry to estimate warranty liability. Note that warranty expense is incurred in the accounting period when the washing machines are sold, not when the repairs are made.
To record estimated liability under warranties for repairs to be performed on washing machines sold in 2017. 200 washing machines sold x 0.05= 10 estimated to need repair. 10 – 3 repaired in 2017 = 7 estimated to be repaired in 2018 at $25 each for estimated liability of $175.
At the end of 2018, the Estimated Liability Under Warranty Obligations account will show a $45 credit balance. Ideally, the balance in this account would be zero if the company’s estimate has been perfect. Since the estimating process is an ongoing one, there is no need to adjust the liability account unless it becomes obvious that the estimates are continually too high or too low. In such cases, a revision of the firm’s estimating process is warranted.
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