INTERMEDIATE ACCOUNTING 2 MODULE

Chapter 3: sold will be returned for repair. The entity incurs P180,000 for
WARRANTY LIABILITY repairs during the year.
Journal Entries:
Objectives:  To record sales.
The learner should be able: Cash 9,000,000
 To understand the nature and purpose of warranty. Sales 9,000,000
 To ascertain the recognition of an estimated warranty  To set up the estimated liability on the warranty.
liability. Warranty expense 300,000
 To know the measurement of an estimated warranty liability. Estimated warranty liability 300,000
 To test the reasonable accuracy of an estimated warranty
liability. Estimated sets to be returned 600 sets
x Estimated warranty cost per set 500____
Estimated warranty cost 300,000
Start of Discussion
 To record the payment of the actual cost.
 WARRANTY Estimated warranty liability 180,000
- Guarantee or warranty to provide free repair service or Cash 180,000
replacement during a specified period if the products are
defective.
b. Expense as incurred approach
 Recognition of Warranty Provision The approach of expensing warranty cost only when actually
PAS 37 provides that a provision shall be recognized as a liability incurred. This approach is justified on the basis of expediency
in the FS under the following conditions: when warranty cost is not very substantial or when the warranty
1. The entity has a present obligation as a result of past event. period is relatively short.
2. It is probable that an outflow of resources embodying
economic benefits would be required to settle the obligation.  Sales made evenly
3. The amount of the obligation can be measured reliably. To have an easier interpretation or understanding of sales
accruing evenly during the year, it is fair to assume that half of
 Accounting for Warranty the sales were made on January 1 and the other half on July 1.
a. Accrual approach
The accrual approach has the soundest theoretical support Illustration:
because it properly matches cost with revenue. An entity sells refrigerators that carry a 2-year warranty against
defects. The sales and warranty repairs are made evenly throughout
 The estimated warranty cost is recorded as follows: the year.
Warranty expense xxx
Estimated warranty liability xxx Based on the past experience, the entity projects an estimated
warranty cost as a percentage of sales as follows:
 When actual warranty cost is subsequently incurred and paid:
Estimated warranty liability xxx First year of warranty 4%
Cash xxx Second year of warranty 10%

 Any difference between estimate and actual cost is a change in 2020 2021
estimate and therefore treated currently or prospectively, if Sales 5,000,000 6,000,000
necessary. Actual warranty repairs 140,000 300,000
 If actual cost > estimate:
Warranty expense xxx Computations:
Estimated warranty liability xxx  Warranty expense related to 2020 sales:
2020
 If actual cost< estimate: 1st contract year of Jan. 1, 2020 sales
Estimated warranty liability xxx (2,500,000 x 4%) 100,000
Warranty expense xxx 1st contract year of July 1, 2020 sales
(2,500,000 x 4% x 6/12) 50,000
Illustration:
An entity sells 1,000 units of television sets at P9,000 each for cash. 2021
Each television set is under warranty for one year. 1st contract year of July 1, 2020 sales
(2,500,000 x 4% x 6/12) 50,000
The entity has estimated from past experience that warranty cost 2 contract year of Jan. 1, 2020 sales
nd

will probably average P500 per unit and that only 60% of the units (2,500,000 x 10%) 250,000
INTERMEDIATE ACCOUNTING 2 MODULE
2nd contract year of July 1,2020 sales
(2,500,000 x 10% x 6/12) 125,000

2022
2nd contract year of July 1,2020 sales
(2,500,000 x 10% x 6/12) 125,000

Total warranty expense for 2020 700,000

 Warranty expense related to 2021 sales:

2021
1st contract year of Jan. 1, 2021 sales
(3,000,000 x 4%) 120,000
1st contract year of July 1, 2021 sales
(3,000,000 x 4% x 6/12) 60,000

2022
1st contract year of July 1, 2021 sales
(3,000,000 x 4% x 6/12) 60,000
2 contract year of Jan. 1, 2021 sales
nd

(3,000,000 x 10%) 300,000

2 contract year of July 1, 2021 sales
nd

(3,000,000 x 10% x 6/12) 150,000

2023
2nd contract year of July 1, 2021 sales
(3,000,000 x 10% x 6/12) 150,000

Total warranty expense for 2021 840,000

The warranty costs after December 31, 2021 represent the

estimated warranty liability on December 31, 2021.

2020 sales still under warranty after December 31, 2021:

2nd contract year of July 1, 2020 sales 125,000

2021 sales still under warranty after December 31, 2021:

1st contract year of July 1, 2021 sales 60,000
2nd contract year of Jan. 1, 2021 sales 300,000
2nd contract year of July 1, 2021 sales 300,000
Estimated warranty liability – Dec. 31, 2021 785,000
Estimated warranty liability per book 1,100,000
Decrease in Warranty Liability (315,000)

-End of Discussion-