How to Record Warranty Liability
It is common for the company to sell its product together with the warranty. Likewise, the company needs to record the warranty liability at the same time of sale if the warranty is attached with the sale.
Warranty liability is the type of contingent liability that the company usually needs to record and disclose as this liability is usually probable and can be reasonably estimated. Likewise, the company usually can reasonably estimate how much the warranty expense will incur based on its past experience.
Record warranty liability with journal entry
The company can record the warranty liability with the journal entry of debiting the warranty expense account and crediting the warranty payable account.
Under the matching principle of accounting, the warranty liability will need to be recorded in the period that the company makes the sale in order to ensure that the warranty expense is matched with its related sales revenue.
When customers come to claim the warranty, the company needs to make the journal entry by debiting the warranty payable account and crediting the related account of the warranty (e.g. cash, inventory, repair parts, etc.).
In this journal entry, the credit side is based on the clause of the warranty and the actual claim that occurs. For example, if the company provides a warranty to replace the damaged product, it will credit the inventory for replacing the merchandising goods.
Record warranty liability with example
For example, during January, the company ABC has sold 10 products for $100,000, all of which include a five-year warranty of repairs. Based on past experience, the average cost of the repairs over the warranty period is estimated to be 8% of the sale price.
In this case, the company ABC can record warranty liability of $8,000 (100,000 x 8%) in the January 31 adjusting entry with the below journal entry:
If this journal entry is not made, both total liabilities on the balance sheet and expenses on the income statement will be understated by $8,000 in the January period.
Later, when the company provides the repairs under the warranty for its customers, it can make the journal entry by the debit of warranty payable and the credit of repair parts.
For example, assume that on April 12, the company ABC makes a repair under warranty that cost $500 of repair parts.
In this case, the company ABC can record the warranty liability on the debit side of the journal entry for the settlement of payable with the repair parts on April 12 as below.