Warranty Expense are an estimated costs that entity might incur in future against sale of goods or services provided.
Warranties are a common practice in the business world.
Entities use warranties as way to show their quality of the products and motivate buyers to choose their products over their competitors.
However, providing warranties comes with the cost for companies.
Warranty expense accounting can be a challenging task, especially for businesses without dedicated accounting departments. In this blog post, we will guide you on recording warranty expense journal entry.
Understanding Warranty Expense Accounting
Before we dive into the steps of recording warranty expense journal entry, let’s get to know some key terms and concepts.
The warranty expense is the total cost incurred by the company for compensation or repair of the products under the warranty period.
The warranty period is the duration during which the company provides support for the product, which can range from a few months to a few years.
Importance of Proper Warranty Expense Recording
Proper recording of warranty expense is important as it helps the company to track the costs related to the warranties they offer. Accurate recording also ensures that the warranty expense is recognized in the correct accounting period, which helps in preparing accurate financial statements.
Recording Warranty Expense Journal Entry
The first step in recording warranty expense journal entry is to determine the warranty expense amount. The amount can be calculated by reviewing historical data of warranty claims or by estimating the future warranty costs based on the industry data.
Determining the Warranty Liability Account
The second step is to determine the liability account associated with the warranty expense. The liability account for warranty claims is usually classified as an accrued liability account.
Accrued liability is to record the expenses which an entity incurs. However, the word incur does not necessarily mean that payment also happened. Therefore we should be record it as a liability on the company’s balance sheet.
Recognizing the Expense and Liability
The third and final step is to recognize both the warranty expense and the warranty liability through a Journal entry.
The warranty expense and warranty liability will be part of company’s income statement and company’s balance sheet as an accrued liability respectively for the current accounting period.
Lets see how to record the journal entry.
Warranty Expense A/c Dr
To Warranty Liability A/c
Impact of Warranty Expense on Financial Statements
Recording warranty expense in the income statement can impact the company’s net income if the warranty expense is significant. If the warranty expense is higher than the company’s revenue for the period, this can lead to a net loss.
In General, the financial performance will not be on loss side just because of the warranty. Warranties might be a major portion on the operating expenses. But its not large enough that it will eat the total revenue of the entity
Effect on Balance Sheet
Recording warranty liability as an accrued liability on the balance sheet can impact the company’s financial position. As the warranty liability increases, it can affect the company’s liquidity ratios and make it difficult for the company to obtain financing.
Proper recording of warranty expense is crucial for ensuring the books of accounts are correct. Accurate recording helps the company to track warranty costs and prepare accurate financial statements.
We can record this similar to any other Operating expenses by debiting the warranty expense and crediting the associated liability. By following the steps outlined in this blog post, you can effectively record warranty expense journal entries and ensure the financial health of your business is accurate.