Accounting for Warranty Revenue
A warranty is a guarantee provided by the manufacturer of a product, committing to repair or replace any defective material within a specified period of time. In essence, it is a promise that the consumer can rely on if something happens to their product.
By offering a warranty, businesses show their customers that they stand behind their products and value satisfaction. From electronics to large appliances, almost any product can be covered under some form of warranty. This helps bring peace of mind to consumers who have purchased and want to protect their products. Warranties help provide assurance that customers will get consistent quality and satisfactory service from the sellers they choose when shopping.
Warranties are an important part of many products, as they give customers the confidence that their purchases will last for a certain amount of time and that they can contact the seller if something goes wrong.
Some warranties come default with the product and some are offered as an add-on purchase to extend the warranty period. Purchasing an extended warranty can be beneficial to customers in the long run, as it usually covers any repairs that may become necessary during its length. Adding on an extended warranty can be especially helpful for larger expenses such as home appliances or electronics, where additional coverage could make all the difference over time.
Whichever type of warranty you choose, make sure you understand how it works and how much coverage it provides so that you can accurately account for costs associated with potential future repairs.
Type of Warranty
Assurance-type warranties
They are guarantees that products or services will remain in good working condition for a period of time after purchase, or will be fixed or replaced if there is an issue during that period. These warranties may cover parts and labor costs associated with repairing a product or providing a replacement. The length of the warranty period varies depending on the type of product and manufacturer, but they usually range from one month to several years.
This warranty is not creating a separate obligation for the company, so it is required to make provisions for service repair to the customers. It is not required to record the warranty revenue on the income statement. The cost of the warranty already includes in the product’s price.
Warranties that provide a service
It is the warranty that the company sells separately to the customers and provides service in addition to assurance. It is optional for the customers, they have the option to purchase the warranty or not. The company has separated performance obligations toward the customers.
A service contract is a type of warranty that a customer can purchase separately from a related good or service. A service contract provides additional protection for a specific period and typically covers repairs, maintenance, or replacements that are not covered under the manufacturer’s warranty.
It is treated as the sale of service to the customers. The company needs to record it as the revenue on the income statement and the cost will be recorded as an expense.
Journal Entry
Assurance-type warranties Journal Entry
When the company sells the product to customers, the company needs to estimate the warranty expense and record it in the same accounting period. It will follow the accounting matching principle. The estimation of the warranty will depend on past experience and management assumptions.
The journal entry is debiting warranty expense and credit provision for warranty expense.
| Account | Debit | Credit |
|---|---|---|
| Warranty Expense | 000 | |
| Provision for Warranty Expenses | 000 |
Warranty expenses will be recorded as expenses on the income statement. Provision for warranty is the liability account on the balance sheet and it will be reversed when the actual warranty incurs.
Warranties that provide a service Journal Entry
The company sells warranty services to customers to cover a long period of time. So it needs to separate the revenue and record it on a monthly basis.
When receiving payment from customers, the company needs to record the unearned revenue. The journal entry is debiting cash and credit unearned revenue.
| Account | Debit | Credit |
|---|---|---|
| Cash | 000 | |
| Unearned Revenue | 000 |
At the end of the month, company needs to reverse the unearned revenue to actual revenue.
The journal entry is debiting unearned revenue and credit revenue.
| Account | Debit | Credit |
|---|---|---|
| Unearned Revenue | 000 | |
| Warranty Revenue | 000 |
Example
Company ABC has sold the car to customers for $ 80,000 on credit, it is attached with one year warranty. Based on the company’s experience, the warranty expense for the first year is $ 5,000. Please prepare journal entry for warranty expenses.
This warranty is the assurance-type warranty that the company provides to the customer to insure the product’s quality.
The journal entry is debiting accounts receivable $ 80,000 and credit sale $ 80,000. At the same time, it needs to record warranty expense $ 5,000 and provision over warranty $ 5,000.
| Account | Debit | Credit |
|---|---|---|
| Accounts Receivable | 80,000 | |
| Warranty Expense | 5,000 | |
| Sale | 80,000 | |
| Provision for Warranty | 5,000 |