Provision for Warranty
Introduction
The company needs to make provision for warranty when it sells the product with the warranty attached to customers. This is due to the warranty will give rise to the liability that the company needs to settle in the future by fulfilling the warranty clause.
Warranty is like a promise that the company gives to customers saying that there won’t be any problem with the product. And if there is, they will repair or replace them free of charge. Of course, there is usually a specific period of time for such promise e.g. 1 year, 3 years or 5 years, etc.
Likewise, the warranty that the company provides to customers will give rise to the contractual agreement that results in future costs that the company may incur in replacing defective units or repairing malfunctioning units. In this case, the product warranty is a type of contingent liability that the company needs to make provision for.
Provision for Warranty Journal Entry
The company usually uses the history information that shows the cost of replacing or repairing the defective or malfunctioning products in order to estimate provision for warranty expense.
Under the matching principle of accounting, the estimated cost of honoring the warranty contracts should be recognized in the period that the sales occur. Likewise, the company needs to make the journal entry to record the provision for the warranty that it gives the customers in order to comply with the accounting rule.
In this case, the company can make the provision for warranty with the journal entry of debiting the warranty expense account and crediting the warranty liability account.
| Account | Debit | Credit |
|---|---|---|
| Warranty expense | 000 | |
| Warranty liability | 000 |
In this journal entry, warranty expense is recorded as an expense item on the income statement while warranty liability is an obligation that the company owes to the customers that bought its products with the warranty. Hence, it is recorded as a liability on the balance sheet. Likewise, this provision for warranty journal entry will increase both total liabilities on the balance sheet and total expenses on the income statement for the period.
And the balance in the warranty liability account will be reduced when there is a warranty claim from the customer. In other words, the warranty liability will be settled when the company reimburses or repairs defective or damaged products for customers.
Likewise, the company can make the journal entry for warranty claim from customer by debiting the warranty liability account and crediting the inventory account for the repair parts that the company uses for repairing the damaged product or for the replacement of the product if it is so stated in the warranty contract.
| Account | Debit | Credit |
|---|---|---|
| Warranty liability | 000 | |
| Inventory | 000 |
In this journal entry, the inventory account represents either the repair parts inventory or the product inventory itself. In other words, the company may need to repair the damaged product or replace the default goods itself. In either case, this journal entry for warranty claims from customers will reduce both total assets and total liabilities on the balance sheet.
Provision for Warranty Example
For example, the company ABC sold 1,000 washing machines with an average price of $400 each in 2022. The selling price includes one-year warranty on parts.
With the prior experiences and historical information, the company expects 5% of products sold to be defective and the average repaired cost for the products will be $60 per unit.
Also, the company honored warranty contracts on 45 products at the total cost of $2,700 during 2022.
What are the journal entries for warranty in the above transactions?
Solution
In order to account for the obligation that occurs as a result of the warranty given, the company ABC can calculate the estimated provision for warranty as below:
Number of units sold: 1,000
Estimated rate of defective units: x 5%
Total defective units: 50
Average repaired cost: x $60
Estimated provision for warranty: $3,000
In this case, the company ABC can make the journal entry for warrant provision in 2022 by debiting the $3,000 estimated provision to the warranty expense account and crediting the same amount to the warranty liability account as below:
| Account | Debit | Credit |
|---|---|---|
| Warranty expense | 3,000 | |
| Warranty liability | 3,000 |
This journal entry will increase both total expenses on the income statement and total liabilities on the balance sheet by the same amount of $3,000 as of 2022.
And the journal entry of honored warranty contracts in 2022 will be the debit of the warrant liability account and the credit of the repair parts inventory account with the $2,700 amount as below:
| Account | Debit | Credit |
|---|---|---|
| Warranty liability | 2,700 | |
| Repair parts inventory | 2,700 |
And this journal entry of honored warranty contracts on 45 products will decrease both total assets and total liabilities on the balance sheet by $2,700 as of 2022.