Accounting for Extended Warranty
Extended Warranty is the warranty that company provides in addition to the normal warranty. The company sells additional warranty to the customer to insure over any damage raised from accidents over the factory warranty.
The manufacturing usually provides a warranty on their new product to ensure that their products can work over a specific period of time. Anything wrong within this period, the company will provide free repair or even replace a new product, it depends on their term and condition. It is the normal warranty that the company provides to customers to ensure that the product will be in good condition at least within the warranty period which is usually one year.
For example, when we purchase a new iPhone from Apple, they will provide a warranty over a period of one year. Any damage will be repaired and the defective products will be replaced based on their term and condition. It helps to ensure that new iPhone will work fine in the first year and there is no defective product sale to customers.
Extended warranty is the service that company sells to customers to provide an additional warranty after the normal warranty ended. The customers may want to insure their product even after the normal warranty period, but instead of providing a free warranty, company sells the service to cover the damage. It works like the insurance over the product when customer paid the fee in exchange for repair or replacement. For example, in addition to a normal warranty, Apple sells AppleCare+ which is an extended warranty service.
Extended Warranty Journal Entry
In order to receive this warranty, customers require to pay in advance, and service will provide a base on the contractual period. The company will receive cash and need to provide service later, so they need to record unearned revenue and recognize income based on a straight-line basis. It should be allocated based on the number of months which is easy and more flexible.
They have to make the following journal entry:
- Journal entry when customer pay extended warranty: The company makes journal entry by debiting cash and credit unearned revenue. Cash will present as a current asset and unearned revenue is the current liability in the balance sheet.
- Journal Entry at the month-end: The company needs to allocate the revenue based on the number of months. At the end of the month, company needs to debit unearned revenue and credit revenue. It will decrease the current liability and it will become zero at the end of contract period. The revenue will be recorded in income statement based on monthly basis.
Extended Warranty Example
Company ABC sells smartphones to customers with a warranty over one year from the purchasing date. In addition to a normal warranty, company also sells the extended warranty which costs $ 120 per year. The extended warranty will count from the end of normal warranty.
Mr. A has purchased a new phone on 01 Jan 202X. Moreover, he also purchase one year extended warranty to insure his phone after the normal warranty.
Mr. A purchases the warranty on the same day that he purchase the phone. In the first year, he will receive a free warranty from the company. In the second year, he will receive the extended warranty, which start from 01 Jan 20X+1 to 31 Dec 202X+1.
On 01 Jan 202X: The company makes journal entry by debiting cash $ 120 and credit unearned revenue $ 120. The unearned revenue will be classified as current liabilities and present on balance sheet.
On 31 Jan 202X+1: At the end of month in second year, we need to recognize the revenue by debiting unearned revenue and credit sale revenue. The company record revenue at the month-end and unearned revenue will be zero at the end of the warranty period.
Extended Warranty for Buyer
An extended warranty is the cost that customers spend to insure the products after a normal warranty. It can help the customer to save on repair and maintenance. It also ensures that the product will be repaired by a certified technician who has enough knowledge of the product. For example, Apple Care, we will confident over the repair service as it performs by Apple-authorized partners only.
The accounting treatment for the extended warranty is similar to the accounting for insurance. We need to record prepayment and reclass it to expense over the period of the extended warranty period. We cannot record them as expenses on the purchase date. It cannot treat as the product cost as well, it has a different term from the product.
The customer does not record any expense related to normal warranty as it is part of the product. It is the company obligation to warrant over the new product, the customer cannot separate the cost of normal warranty from the product. Moreover, they do not have the option to purchase products without normal warranty. The normal warranty automatically attaches to a new product from the factory to ensure that the product go through quality control.
Extended warranty is a separate service that supplier sells to customers. It is another business transaction that needs to account separately. It has separate costs which require separate entry from the original product.
Extended Warranty for Buyer Example
Company XYZ purchase a new car that cost $ 50,000 on 01 January 202X. The car manufacture provides insurance for the new car for one year. Anything happens to a car, the manufacture will provide free repair as long as it falls under their term and condition. This warranty will cover from 01 Jan 202X to 31 Dec 202X.
In addition, the manufacture also sells the extended warranty after the end of normal warranty. Customer needs to pay $ 1,200 per year to receive the cost of repair over a certain condition. On 01 Jan 202x+1, XYZ decide to purchase this additional warranty for one year after the normal warranty ended.
On 01 Jan 202X, XYZ needs to record the vehicle as normal. They do not need to record warranty expenses as there is no warranty cost in the purchase. It is attached to the new car.
The company should make a journal entry by debiting fixed assets and credit cash of $ 50,000.
|Fixed Assets – Vehicle||50,000|
These fixed assets will depreciate as normal. There is no other journal entry related to a normal warranty.
On 01 Jan 202X+1, XYZ has purchased the extended warranty for $ 1,200 to cover the repair for one year. We need to credit cash paid to the supplier, but we cannot debit the warranty expense as the warranty cover a period of one year. So we need to record prepaid expenses and amortize them over the period of the warranty term.
The company needs to make journal entry by debiting prepaid expenses and credit cash of $ 1,200.
|Prepaid Expense – Warranty||1,200|
A prepaid expense is the current assets that will be present on balance sheet, it has not yet impacted the income statement.
At the end of the month, company needs to recognize expense by reclass prepaid expense and warranty expense. The prepaid expense must be recorded as an expense based on the term of the warranty.
The company needs to debit warranty expenses and credit prepaid expenses.
Warranty expense will impact the income statement by deducting profit. We recognize expenses based on the term of extended warranty by allocating the expense to each month. The company needs to make the same journal entry over the period of 12 months.
At the end of the warranty extended period, the prepaid expense will be zero, and the total warranty expense will be $ 1,200. It is the concept that expense records are based on occurrence.