NOTRE DAME OF MIDSAYAP COLLEGE

Midsayap, Cotabato

COLLEGE OF BUSINESS AND ACCOUNTANCY

LEONISA GUERRERO TORINO

BSA 2
INTERMEDIATE ACCOUNTING 2
CHAPTER 3 DISCUSSIONS

1. Explain warranty.
A warranty is a type of guarantee that a manufacturer or similar party makes regarding the
condition of its product. It also refers to the terms and situations in which repairs or exchanges will
be made if the product does not function as originally described or intended.
A warranty in contract law is an undertaking not a condition or an innominate term of the
agreement: it is a term "not the roots of the contract," which only allows an innocent party to
receive compensation where it is infringed. This means that the warranty is not valid or, in
compliance with the terms of the assurance, that the defaulting party does not perform the
contract. A guarantee is not a guarantee. No guarantee. It's just an assurance. It can be applied if an
award for the legal compensation of damages is broken. A guarantee is a contract term. A product
guarantee may cover, depending upon the conditions of the contract, a producer offers a customer
guarantee that does not specifically apply to the producer. The warranty is given by the
manufacturer. An explicit or implicit warranty may be. An express guarantee is explicitly expressed
(usually written), and depends on the particular contract law of the country in question, whether a
term is implied in the contract or not. Guarantees may also state that a specific fact is true at one
point or that the event continues (a "continuing warranty").
Home appliances like television sets, stereo sets, ratio sets, refrigerators and the like are
often sold under guarantee or warranty to provide free repair service or replacement during a
specified period if the products are defective. Such entity policy may involve significant costs on the
part of the entity if the products sold prove to be defective in the future within the specified period
of time.

2. What are the conditions for the recognition of a warranty provision?

PAS 37, paragraph 14, provides that a provision shall be recognized as a liability in the
financial statements under the following conditions:
a. The entity has a present obligation, legal or constructive, as a result of a past event.
b. It is probable that an outflow of resources embodying economic benefits would be
required to settle the obligation.
c. The amount of the obligation can be measured reliably.
3. Explain the accrual approach of accounting for warranty cost.
The accrual approach has the soundest theoretical support because it properly matches cost
with revenue. Following this approach, the estimated warranty cost is recorded as follows:
Warranty expense xxx
Estimated warranty liability xxx

When actual warranty cost is subsequently incurred and paid, the entry is:
Estimated warranty liability xxx
Cash xxx
At a certain date, the estimate is reviewed to determine its reasonableness and accuracy. The
actual warranty cost is analyzed to validate the original estimate. Any difference between estimate and
actual cost is a change in estimate and therefore treated currently or prospectively, if necessary.
Thus, if the actual cost exceeds the estimate, the difference is charged to warranty expense as
follows:

Warranty expense xxx

Estimated warranty liability xxx

If the actual cost is less than the estimate, the difference is an adjustment to warranty expense as
follows:
Estimated warranty liability xxx
Warranty expense xxx

A firm may have a guarantee policy that assures consumers that within a number of days of
the selling date they will fix or replace those forms of damage to their goods. If it is necessary for
the company to accurately predict the amount of warranty claims expected to occur under the
scheme, the expense of these anticipated claims should be paid. In the same reporting cycle, the
accruing is to take place in the connected product sales. This is the most reliable indicator of all the
costs associated with the selling of goods and therefore of the actual profitability of the sales.
If management changes the warranty period, the warranty costs will change not only for
certain sales in the present period but also for sales over the previous years, the assurances of
which are now extended over the current period. If, instead, the cost of guarantee claims can only
be acknowledged when the organization processes consumer actual claims, the costs may not be
known until a few months after the related sales. In this method, the financial reporting will
produce incredibly high initial income and, as long as the assured duration lasts, depressed profits
during later months.
If there is no information from which a guarantee calculation can be extracted for use in an
accrual, consider using industry information about the guarantee statements. If there is a large
amount of guarantee expenditure reported, expect the auditors of the company to study. If so, plan
the history and the relationship between costs incurred and the amount of sales or units associated
with the actual cost of guarantees. This knowledge can then be attributed to existing levels of
revenue and is used to explain the amount of the warranty. If the duration of guarantee claims lasts
past one year, the accrued guarantee costs can be divided into a short-term liability of those
anticipated for one year and a long-term liability in respect of those expected for more than one
year.
 The basic principle of accounts for accruals is that income is recognized when income is
finished and not actually payed for goods or services. For more about accounting bases, click here.
In certain cases, it is very straightforward to decide when the income process is completed. - time a
customer has a drink; a bar allows employers to use a tab has a completed earning phase. However,
the completion of the benefit process in many firms is not as clear. Take the example of the sellers
of goods giving purchasers assurances. Many, if not the majority of consumer products are
marketed under such product guarantees. All of this involves microwaves, computers, cars and
trucks. Another problem for accrual accounting is selling goods subject to guarantees.

4. Explain the expense as incurred approach of accounting for warranty cost.

The expense as incurred approach is the approach of expensing warranty cost only when
actually incurred. This approach is justified on the basis of expediency when warranty cost is not
very substantial or when the warranty period is relatively short.
The warranty expenses are those that the company anticipates or has already incurred in
fixing or replacing products sold. The overall warranty cost is limited to the warranty duration
usually allowed by the company. When a product has finished in the contract, a corporation no
longer takes responsibility for the warranty. From such an accounting point of view, warranty costs
should be accepted as possible and calculated according to the Financial Accounting Standards
Board (FASB). The business will debit (charge) the guarantee expenses account and loan (swap) a
liability account when recording the case in the financial statements, when the commodity is sold
to a buyer. The Company would eliminate all liabilities and inventory accounts as the replacement
product would be excluded from the inventory if the product was deficient and needed to be
replaced. If the damaged product has to be fixed or reimbursed, then the expense decreases the
accounts of obligation. Warranty expenditure is recognized for selling goods during the same time
as the profits if it is likely to incur an expense and the company can estimate the expense amount.
This practice is known as the matching principle if, in the same time, all spending for a commodity is
recognized jointly. When a sale happens, the income balance will be affected by the full amount of
the guarantee cost even though no guarantee claims are made during the term and are part of
COGS. In subsequent accountability periods, the expense of lawsuits would decrease the liability
account for assurances.
The cost of warranty is recognized for the goods sold during the same time as for sales if it is
possible to incur an expense and the company may estimate the amount of the expense. This is
referred to as the matching concept, where all selling costs are reported within the same reporting
period as sale revenue.

5. Explain the sale of an extended warranty.

A warranty is sometimes sold separately from the product sold. When products are sold, the
customers are entitled to the usual manufacturer's warranty during a certain period.
However, the seller may offer an "extended warranty" on the product sold but with
additional cost.
In such a case, the sale of the product with the usual warranty is recorded separately from
the sale of the extended warranty. The amount received from the sale of the extended warranty is
recognized initially as deferred revenue and subsequently amortized using straight line over the life
of the warranty contract.
However, if costs are expected to be incurred in performing services under the extended
warranty contract, revenue is recognized in proportion to the costs to be incurred annually.
 An extended warranty is offered at additional price when you sell products, such as
computers, cellular phones, washing machines or facilities, such as commercial services. An
expanded guarantee is distinct from that of a warranty given free of charge by a retailer. This also
differs from the assurances implied by the CGA, which only occur under limited situations and can
be avoided.
Extended warranties are a form of insurance covering repair or replacement costs of goods
with defects in the factory. They make decent money for retailers, but they'll never have to be used
by relatively few consumers. Note, there is also a manufacturer guarantee on many new appliances
and electronics which is good for over a year. A longer warranty or service contract acts like an
insurance contract for the product that you purchase and is usually offered at the point of sale by
the manufacturer, although it may also be purchased from third parties. 1 While the price of an
extended warranty sometimes seems to be a trade in contrast to the steep repair price, it is
important to note that retailers and other providers provide guarantees for one specific reason:
they make money. Because the extended warranty is in the future for an extended time, sales
proceeds are initially unearned, and are then postponed and recognised for the extended
guarantee period. As the revenue is postponed, no expense is incurred at the start of the extended
guarantee arrangement in compliance with the matching principle. This is in contrast with the
regular guarantee offered in the buy price of a commodity in cases of not delaying revenue and of
immediate identification and matching of contingent responsibility for warranty costs. Companies
use probability metrics to measure the probability of repair of your new fridge, flat screen TV, or
vehicle.The business that provides policies obviously looks forward to coming forward. Enlarged
guarantees for retailers can be big money makers. 2 The 2019 global demand for service contracts
is expected to hit $120.8 billion by 2027, according to data from Allied Market Research.
The next time you make a big purchase, such as a washing machine or TV, the manufacturer
will try to sell you another item in the register: an enhanced warranty on the new product. These
extended provisions also appeal to thrifty buyers who make difficult choices when purchasing costly
products by providing coverage beyond the original manufacturer's warranty period. It's difficult to
be persuaded by the extended guarantee pitch when you pull the wallet to pay for a large ticket
item, even though it raises purchases costs by hundreds of dollars. But are extended assurances
valuable? In most situations, when you consider their expenses and the very poor probability of
actually paying them, the advantage of such contracts starts to vanish.

REFERENCES:

BOOK - Valix, C.T., Peralta, J.F., & Valix, C.A.M. (2020). Intermediate Accounting Volume 2:
Chapter 3: WARRANTY LIABILITY. GIC ENTERPRISES & CO., INC
https://www.investopedia.com/terms/w/warranty.asp
Ammons, D. N., & Condrey, S. E. (1991). Performance appraisal in local government: Warranty conditions.
Public Productivity & Management Review, 253-266.

Balachander, S. (2001). Warranty signalling and reputation. Management Science, 47(9), 1282-1289.

Blischke, W. (1995). Product warranty handbook. CRC Press