Warranty Expense
A cost associated with fixing, replacing, or compensating a customer for product flaws.
Updated:
September 15, 2022A warranty is a promise that a producer or comparable entity makes about the state of its goods. It also refers to the conditions and circumstances under which fixes or exchanges will be provided if the product does not perform as originally intended or stated.
Limiting conditions are expected in warranties. For the manufacturer to uphold the guarantee, the customer must perform certain obligations.
A warranty expense is a cost associated with fixing, replacing, or compensating a customer for product flaws.
In other words, if a product supplied by a vendor or manufacturer breaks or fails to operate as intended under the warranty, the vendor or manufacturer is obligated to fix or replace the product.
This service is provided to draw in consumers for various goods, particularly consumer durables like refrigerators, televisions, cars, etc.
The conditions of the warranty must be upheld for the length of the business's warranty period. After the period has passed, enterprises are no longer liable for contracts.
These costs are recorded simultaneously as sales of the purchased goods. It is based on the matching principle, which states that all costs associated with a sale are recorded in the same reporting period as the income from the related transactions.
Types of Warranties
Express and implied warranties are the two main categories of warranty. Different subtypes are available with specific terms, conditions, and guarantees.
1. Implied
A product's fitness for use and satisfaction with the buyer's expectations are guaranteed by an implied warranty. These implicit guarantees may be expressed orally or in writing.
Federal law is not relevant when it comes to implied guarantees.
Fitness and merchantability are the two main categories of implied guarantees.
A product must be suitable for its intended use to be considered fit for sale, which implies it must reasonably satisfy the buyer's expectations.
When vendors show and sell an excellent suitable for a specific function, implied guarantees also apply. To acquire the product, the customer relies on the seller's knowledge. Assurances include any claims the merchant makes about the goods.
2. Expressed
An express warranty, as its name indicates, is a written assurance given to a customer by a manufacturer or seller that the item they have purchased will meet their expectations.
If there are flaws, the vendor is willing to make repairs or replace the broken item. The warranty may be stated verbally, on paper, on the product, or elsewhere.
Exaggerated statements made to grab customers' attention are not described as a guarantee in any form. Instead, they promote a product and draw buyers in (puffery).
Terms of the warranty might range from free repairs on the damaged item to total replacement. In addition, the owner may be given the option of shipping the item to the manufacturer, the vendor, or the closest authorized repairman.
Although many other warranty subtypes exist, extended warranties and particular warranty deeds are the most popular.
Extensive warranties are offered on items with a high value, such as automobiles, electronics, and appliances. The manufacturer would carry out the extended warranty on behalf of the consumer, even if the merchant sold it.
Particular warranty deeds are used to transfer real estate ownership. They guarantee the buyer that the title is clear of any liens, claims, or encumbrances at the time of sale-this deed grants ownership to the grantee with an express assurance of title.
Denied Warranty Claims
Typically, warranties only cover goods that have not been changed or modified after being bought.
For instance, some people like swapping car exhausts or improving a vehicle's transmission to achieve a specific performance.
Due to their potential to have unintended dependability effects on the vehicle for which the dealer and manufacturer are not liable, many modifications have the potential to void the warranty protection for the modified and impacted components.
Each business has a distinct procedure for handling warranties. Even if a warranty covers a device, the manufacturer may want further evidence to prove that it malfunctioned under ordinary usage.
The warranty is unlikely to be fulfilled if the product malfunctions due to the owner's activities rather than a flaw in the manufacturing or design. For instance, the product's owner could have put it in a location too hot or cold for it to be used as intended.
It is simple to get confused about the coverage that a warranty offers. However, if you think a warranty should cover a specific problem you faced with a product, make sure you read the warranty and any instructions, then speak with the seller before contacting the manufacturer.
A lawsuit or a complaint to law enforcement should be brought up against the manufacturer if it is denied again.
How to Account For Warranty Expense
In terms of accounting, if it is likely that an expense will be incurred, and the company can estimate the expense's size, warranty expense is recognized in the same period as the sales for the products sold, according to the Financial Accounting Standards Board (FASB).
All costs associated with a sale are recorded within the same reporting period as the sale's income; this is known as the matching principle.
First, you should find the historical ratio of warranty costs to sales for the same categories of products for which the warranty is being decided now.
To calculate the warranty expenditure that has to be incurred, apply the same proportion to the sales for the current accounting period.
This number may be changed to reflect unexpected circumstances relating to the sold items, such as preliminary findings indicating a recent batch of the products had an extremely high failure rate.
Even if there are no warranty claims during the period, if the warranty expenditure is included in COGS, the income statement is affected when a sale occurs.
The expenses incurred will be deducted from the warranty liability account when claims are made in succeeding accounting periods.
Example
The number of product units that will require Repair or replacement must first be estimated to determine the warranty expense.
Units for Repair = Number of Units Sold * Percentage of Defective Units
Then, we have to estimate the costs for the repairs (warranty expense).
Repair Expenses = Units for Repair * Cost of Repair per Unit
XYZ Co. sells vending machines. A one-year warranty is included with each unit against any manufacturing flaws.
Based on the preceding five years of operation, the firm anticipates that 5% (defect rate) of the vending machines sold in the current year will be returned due to a problem. When this occurs, the business repairs the faulty items produced at the cost of $1,000 per unit.
The business sold roughly 200 machines in 2021.
The assignment is to calculate the warranty expenditure that the business needs to report for 2022.
First, we determine how many units the firm anticipates will require replacement or Repair by the warranty agreement:
200 units sold x 5% defect rate = 10 vending machines are potentially defective
Next, we determine how much it will cost to replace the broken machines.
Estimated warranty expense:
$10,000 (10 possible defective units x $1000 replacement cost)
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