Warranties

Definition

A warranty is a promise made by a seller to a buyer to repair or replace a product that fails to perform as expected within a specified period. In financial accounting, warranties are recorded as liabilities because they represent future obligations.

5 Must Know Facts For Your Next Test

1. Warranties are considered contingent liabilities because their realization depends on the occurrence of future events.
2. The expense related to warranties should be recognized in the same period as the sale of the product.
3. Two main types of warranties are assurance-type and service-type warranties; only assurance-type warranties are typically recorded as liabilities.
4. Estimating warranty liability involves historical data and management judgment about future claims.
5. The journal entry for recording warranty expense typically includes a debit to Warranty Expense and a credit to Warranty Liability.

Review Questions

• Why are warranties classified as contingent liabilities?
• What is the difference between assurance-type and service-type warranties in terms of accounting treatment?
• How do companies estimate their warranty liabilities?

Related terms

Contingent Liabilities:

Potential liabilities that depend on the outcome of future events.

Provision: An amount set aside from profits for future liability payments, including potential warranty claims.

Accrued Expenses:

Expenses that have been incurred but not yet paid, often including estimated warranty costs.