Question

During 2017, Eaton Co. introduced a new product carrying a two-year warranty against defects. The estimated warranty costs related to dollar sales are 4% within 12 months following sale and 6% in the second 12 months following sale. Sales and actual warranty expenditures for the years ended December 31, 2017 and 2018 are as follows:
Actual Warranty

Sales Expenditures

2017 $ 400,000 $8,000

2018 600,000 14,000

$1,000,000 $22,000

At December 31, 2018, (assuming the accrual method) what amount should be reported as an estimated warranty liability?
Why are warranties recorded as an expense in the year of the sale, i.e., what accounting principle applies?

Answer 1

Answer:

1. $82,000

2. Accrual / Matching Principle

Explanation:

The two year warranty against defects is known as an Assurance Type Warranty.

With  Assurance Type Warranty, there is no option on the customer to take the warranty or not. Therefore this is not a separate performance obligation.

Assurance Type Warranty are accounted for in terms of IAS 37 Provisions.

At December 31, 2018, the Warranty Expense is calculated as follows :

Sales 2017 : $ 400,000 × 6%   = $ 24,000

Sales 2018 : $ 600,000 × 12% =  $ 72,000

Total                                          =  $ 96,000

Journal

Warranty Expense $ 96,000 (debit)

Warranty Provision $ 96,000 (credit)

When Warranty Claim is Subsequently received in 2018 the entries will be as follows :

Journal

Warranty Provision $14,000 (debit)

Cash $14,000 (credit)

Thus Warranty Liability will be : $ 96,000 - $14,000 = $82,000