CHAPTER 3 WARRANTY LIABILITY TECHNICAL KNOWLEDGE To understand the nature and purpose of warranty. To ascertain the recognition of an estimated warranty liability. To test the reasonable accuracy of an estimated warranty liability. 71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. . There are two approaches in recording the warranty expense, namely accrual approach and expense as incurred approach. Accrual approach The accrual approach has the soundest theoretical support because it properly matches cost with revenue. Under the accrual approach, the estimated warranty cost is accrued and recorded as an expense and estimated liability. Warranty expense xx Estimated warranty liability 7 bs When actual warranty cost is subsequently incurred and paid, the entry is: Estimated warranty liability xX Cash xx 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. Warranty expense Xx Estimated warranty liability xx If the actual cost is less than the estimate, the difference is an adjustment to warranty expense. Estimated warranty liability XX Warranty expense xx 72Illustration An entity sold 1,000 units of television sets at P9,000 each for cash during the current year. Each television set is under warranty for one year. The entity estimated from past experience that warranty cost will probably average P500 per unit and that only 60% of the units sold will be returned for repair. The entity incurred P180,000 for repairs during the current year. Accrual approach 1. To record the sale: Cash 9,000,000 Sales 9,000,000 2. To set up the estimated warranty liability: Warranty expense 300,000 Estimated warranty liability 300,000 Estimated sets to be returned (60% x 1,000) 600 sets Multiply by estimated warranty cost per set 500 Estimated warranty cost * 300,000 3. To record the payment of the actual cost: Estimated warranty liability - 180,000 Cash 180,000 The statement of financial position at the end of the year would report estimated warranty liability of P120,000 as a current liability. If the warranty runs over a period of more than one year, a portion of the estimated warranty liability shall be reported as current liability and the remaining portion as noncurrent liability. Expense as incurred approach The expense as incurred approach is the approach of expensing warranty cost only when actually incurred. The expense as incurred approach is justified on the basis of expediency when warranty cost is not very substantial or when the warranty period is relatively short. The actual warranty cost of P180,000 is simply recorded by debiting warranty expense and crediting cash. 73Another illustration An entity sells refrigerators that carry a 2-year warranty against defects, The sales and warranty repairs are made evenly throughout the year. Based on past experience, the entity projects an estimated warranty cost as a percentage of sales. 4% First year of warranty Second year of warranty 10% 2022 2028 Sales : 5,000,000 6,000,000 Actual warranty repairs 140,000 300,080 Journal entries 2022 1. To record the sale: Cash 5,000,000 Sales . 2. To record the warranty expense: 5,000,000 Warranty expense 700,000 Estimated warranty liability (14% x 5,000,000) Note that the total warranty expense each year is 14% to be incurred over a 2-year warranty period. 700,000 3. To record the actual warranty repairs: Estimated warranty liability 140,000 Cash 140,000 2023 1. To record the sale: Cash 6,000,000 Sales 6,600,000 2. To record the warranty expense: Warranty expense 840,000 Estimated warranty liability 840,000 (14% x 6,000,000) 3. To record the actual warranty repairs: Estimated warranty liability 300,000 Cash 300,600 74Testing the accuracy of warranty liability On December 81, 2023, the estimated warranty liability of P1,100,000 may be analyzed based on the 4% and 10% estimate to determine whether the actual warranty costs approximate the estimate. Warranty expense: 2022 700,000 2023 840,000 1,540,000 Actual warranty repairs: 2022 140,000 2023 300,000 440,000 Estimated warranty liability -December 31, 2023 1,100,000 Sales made evenly To have an easier interpretation or understanding of sales accruing evenly during the year, it is fair to assume that half of the sales were made on January 1 and the other half on July 1. Thus, the first contract year under a 2-year warranty of the sales made on January 1, 2022 will be within January 1, 2022 to December 31, 2022, and the second contract year will be within January 1, 2023 to December 31, 2023. The first contract year under a 2-year warranty of the sales made on July 1, 2022 will be within July 1, 2022 to June 30, 2023, and the second contract year will be within July 1, 2023 to June 30, 2024. Breakdown of sales made evenly in 2022 January 1,2022 (5,000,000 x 1/2) 2,500,000 July "1, 2022 (5,000,000 x 1/2) 2,500,000 Total sales in 2022 Breakdown of sales made evenly in 2023 January 1, 2023 (6,000,000 x 1/2) 3,000,000 duly 1,2023 (6,000,000 x 1/2) 3,000,000 Total sales in 2023 000,000 15Warranty expense related to 2022 sales 2022 - First contract year of January 1, 2022 sales (2,500,000 x 4%) First contract year of July 1, 2022 sales (2,500,000 x 4% x 6/12) 2023 First contract year of July 1, 2022 sales (2,500,000 x 4% x 6/12) Second contract year of January 1, 2022 sales (2,500,000 x 10%) Second contract year of July 1, 2022 sales (2,500,000 x 10% x 6/12) 2024 Second contract year of July 1, 2022 sales (2,500,000 x 10% x 6/12) Total warranty expense for 2022 Warranty expense related to 2023 sales 2023 First contract year of January 1, 2028 sales (3,000,000 x 4%) First contract year of July 1, 2023 sales (3,000,000 x 4% x 6/12) 2024 First contract year of July 1, 2023 sales (3,000,000 x 4% x 6/12) Second contract year of January 1, 2023 sales (3,000,000 x 10%) Second contract year of July 1, 2023 sales (3,000,000 x 10% x 6/12) 2025 Second contract year of July 1, 2023 sales (3,000,000 x 10% x 6/12) Total warranty expense for 2023 76 100,000 50,000 50,000 250,000 125,000 120,000 60,000 60,000 300,000 150,000 150,000 840,000Warranty liability on December 31, 2023 The warranty costs after December 31, 2023 represent the estimated warranty liability on December 31, 2093. 2022 sales still under warranty after December 31, 2023: Second contract year of July 1, 2022 sales 125,000 2028 sales still under warranty after December 31, 2023: First contract year of July 1, 2023 sales 60,000 Second contract year of January 1, 2023 sales 300,000 Second contract year of July 1, 2023 sales (150,000 + 150,000) 300,000 Estimated warranty liability December 31, 2023 785,000 Estimated warranty liability per book 1,100,000 Decrease in warranty liability (315,000) The decrease in warranty liability is an adjustment of the warranty expense of 2023. Estimated warranty liability 315,000 Warranty expense 315,000 17Sale of warranty = ee 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 18 recognized in proportion to the costs to be incurred annually. Illustration Anentity sold a product for P3,000,000. The regular warranty period for the product is two years. The entity sold an additional warranty of two years at a cost of P60,000. The sale is recorded as: Cash 3,060,000 Sales 3,000,000 Unearned warranty revenue 60,000 The extended warranty contract starts only after the expiration of the regular two-year warranty period. If the costs are incurred evenly, the unearned warranty revenue is amortized at the end of the third year on a straight line basis: Unearned warranty revenue 30,000 Warranty revenue (60,000/2 years) 30,000 78QUESTIONS 1. Explain warranty. 2. What are the conditions for the recognition of a warranty provision? 3. Explain the accrual approach of accounting for warranty cost. 4. Explain the expense as incurred approach of accounting for warranty cost. 5. Explain the sale of an extended warranty. 19PROBLEMS Problem 3-1 (IAA) ith a two-year Socorro Company sells color television sets wi P15,000. The repair warranty. The sale price for each set is average repair cost per set is P800. Research has shown that 20% of all sets sold are repaired in the first year and 40% in the second year. 2022 2023 Number of seta sold | 300 500 40,000 150,000 ‘Total payments for warranty repairs Required: 1. Prepare journal entries in connection with the warranty using the expense as incurred approach. 2, Prepare journal entries in connection with the warranty using the accrual approach. 3, Determine the estimated warranty liability on December 31, 2023 as recorded. 4, Analyze the estimated warranty liability on December 31, 2023 to ascertain whether actual warranty costs approximate the estimate. The sales and warranty repairs are made evenly during the year. a Prepare journal entry to correct the estimated warranty liability on December 31, 2023 80Problem 3-2 (AICPA Adapted) In 2022, Daré Company began selling a new calculator that carried a two-year warranty against defects. The entity projected the estimated warranty cost as a percent of sales. First year of warranty 4% Second year of warranty 10% Sales and actual warranty repairs were: 2022 2023 Sales 5,000,000 9,000,000 Actual warranty repairs 200,000 560,000 Required: 1 Prepare journal entries in connection with the warranty using the expense as incurred approach. Prepare journal entries in connection with the warranty using the accrual approach. Determine the estimated warranty liability on December 31, 2023 as recorded. Analyze the estimated warranty liability on December 31, 2028 to ascertain if adjustment is necessary. The sales and warranty repairs are made evenly during the year. Prepare the adjustment to correct the estimated warranty liability on December 31, 2023. 81Problem 3-3 (IAA) im 2022, Plumpton Company started selling new computer chat cared a 2-year warranty against defects. Based on the manufacturer's recommendations, the entity estimated warranty cost as a percentage of sales. First year of warranty = Second year of warranty ba Sales and actual warranty repairs were: 2022 2023 Salen 5,000,000 7,000,000 Actual warranty repairs 100,000 250,000 Required: J, Prepare journal entries to record the transactions for 2022 and 2023, 2, Analyze the estimated warranty liability on December 31, 2023 to ascertain if the actual repairs approximate the estimate. The sales and repairs occur evenly throughout the year, 3, Prepare the adjustment of the estimated warranty liability on December 31, 2023. 82Problem 3-4 (IAA) Sony Company sells stereos under a 2-year Warranty contract that requires the entity to replace defective parts and provide free labor on all repairs. In early 2022, 1,000 units were sold at P9,000 each. Inearly 2028, the entity sold an additional 900 units at P9,250 each. Based on past experience, the estimated 2-year warranty costs are P200 for parts and-P250 for labor per unit. It is also estimated that 40% of the warranty expenditures will occur in the first year and 60% in the second year. Actual warranty expenditures were: 2022 2023 Stereos sold in 2022 180,000 280,000 190,000 Stereos sold in 2023 Required: 1. Prepare journal entries for 2022 and 2023. 2. Determine the estimated warranty liability on December 31, 2023 as recorded. 3. Analyze the estimated warranty liability to prove the reasonable accuracy of the balance on December 31, 2023. 4. Prepare the adjustment of the estimated warranty liability on December 31, 2023. 83Problem 3-5 (AICPA Adapted) Dawson Company manufactures television components and sells them with a 6-month warranty under which defective components will be replaced without charge. On January 1, 2022, the warranty liability had a balance of P620,000. By June 30, 2022, the warranty liability on January 1, 2022 had been reduced to P120.400 by debits for estimated net cost of components returned that had been sold in 2021. The 2ntity started out in 2022 expecting 7% of sales to be returned. However, due to the introduction of new models during the year, this estimated percentage of returns was increased to 10% on May 1. It is assumed that no components sold during 4 given month are returned in that month. Each component is stamped with a date at time of sale so that the warranty may be properly administered. The following table of percentages indicates the likely pattern of sales returns during the 6-month period of the warranty, starting with the month following the sale of components. Percentage of total Month following sale returns expected First 20% Second 20 Third 20 Fourth through sixth — 10% each month we 100% 84Gross sales of components for the first six months of 2022 were: Month Amount Month Amount January 4,200,000 April 3,250,000 February 4,700,000 May 2,400,000 March 3,900,000 June 1,900,000 The warranty also covers the payment of freight cost on defective components returned and on the new components sent out as replacements. The freight cost runs approximately 5% of the sales price of the components returned. The manufacturing cost of the components is roughly 70% of sales price, and the salvage value of returned components averages 10% of their sales price. Returned components on hand on January 1, 2022 were thus valued in inventory at 10% of their original sales price. Required: 1. Determine the estimated sales returns subsequent to June 30, 2022. 2. Determine the required estimated warranty liability on June 30, 2022. 3. Prepare the adjustment of the estimated warranty liability on June 30, 2022. 85Problem 3-6 (IAA) Hanna Company reported warranty expense of P1,900,000 for the current year. The warranty liability account merease by P200,000 during the current year. What amount should be reported for actual warranty expenditures during the current year? a. 1,900,000 b. 1,700,000 c. 2,100,000 d. 0 Problem 3-7 (IAA) Pink Company had a warranty liability of 350,000 at the beginning of current year and P310,000 at end of current year. Warranty expense was based on 4% of sales which ‘amounted to P50,000,000 for the current year. What amount of warranty expenditures was incurred for the current year? a. 2,040,000 b. 1,900,000 c. 2,000,000 d. 0 Problem 3-8, (IAA) Carpet Company had a balance of P800,000.in the estimated warranty liability account on December 31, 2022. The warranty expenditures totaled P2,500,000 for 2023. The warranty expense was calculated at 6% of sales. Sales amounted to P40,000,000 for 2023. What amount should be reported as estimated warranty liability on December 31, 2023? a. 2,400,000 b. 3,200,000 c. 700,000 d. 800,000 86Problem 3-9 (AICPA Adapted) Mill Company sells washing machines that carry ¢ three-year warranty against manufacturer's defects. Based on entity experience, warranty costs are estimated at P300 per machine. During the current year, the entity sold 2,400 washing machines and paid warranty costs of P170,000. 1, What amount should be reported as warranty expense for the current year? a 170,000 b. 240,000 e 550,000 a. 720,000 What amount should be reported as estimated warranty liability at year-end? 1 a. 550,000 b. 720,000 e 170,000 dy 0 Problem 3-10 (AICPA Adapted) Bold Company estimated annial warranty expense at 2% of » annual net sales. The net sales for the current year amounted to P4,000,000. At the beginning of current year, the warranty liability was P60,000 and the warranty payments during the current year totaled P50,000. 1, What amount should be reported as warranty expense for the current year? a. 70,000 b. 50,000 ce. 80,000 d. 60,000 iy What amount should be reported as estimated warranty . liability at year-end? a. 10,000 b. 70,000 ce. 80,000 d. 90,000 87Problem 3-11 (AICPA Adapted) On April 1, 2022, Ash Company began offering a new Pr for sale under a one-year warranty. Of the 50,000 units in inventory at April 1, 2022, 80,000 had been sold by June 30, 2022. : . Based on experience with simi the entity estimated that the average warran' sold would be P80. ( Actual warranty costs incurred from April 1 th 30, 2022 totaled P700,000. 1. What amount should be reported as warrant for 2022? a. 2,400,000 b. 4,000,000 c. 2,000,000 d. 1,200,000 2 On June 30, 2022, what amount should be reported as estimated warranty liability?, a. 1,600,000 b. 3,300,000 ce. 1,700,000 d. ‘900,000 Problem 3-12 (AICPA Adapted) oduct lar products, ty. cost per unit rough June y expense Villa Company estimated annual warranty expense at 8% of net sales. The following data relate to the current year: Warranty liability, January 1 Before adjustment After adjustment 100,000 debit 540,000 credit What amount should be reported as net sales for the current year? a. 8,000,000 b. 6,750,000 c. d 5,500,000 1,250,000 88Problem 3-18 (IAA) Bags Company manufactures high-end home electronic ayetems, The entity provides a one-year warranty for all products: sold, ‘The entity estimated that the warranty cost is P200 per unit sold and reported a liability’ for estimated warranty cost of P650,000 at the beginning of the year. During the current year, the entity sold 5,000 units for a total of P9,000,000 and paid warranty claims of P750,000 on current and prior year sales. What amount should reported as estimated warranty liability at year-end? a, 250,000 b, 350,000 ce. 900,000 a. 750,000 Problem 8-14 (AICPA Adapted) Precise Company sells an electric timer that carries a 90-day unconditional warranty against product failure. The warranty costs of known failures have already been reflected in the records. Based on_a reliable statistical analysis, 2% of units sold during the year will require an average cost of P150 per unit. October November December Units sold 32,000 28,000 40,000 Known product failures from sales of: October 160 320 160 November 80 280 December 180 What amount should be reported as estimated warranty liability at year-end? a. 300,000 b. 123,000 ¢c. 177,000 d. 0 89Problem 3-15 (AICPA Adapted) In 2022, Dubious Company began selling new line of products that carry a two-year warranty against defects. Based upon past experience with oth estimated warranty costs as a percentage er products, the entity of peso sales. First year of warranty ee Second year of warranty 2022 2028 Sales 5,000,000 7,000,000 Actual warranty cost 100,000 800,000 expense ae What amount should be reported as warranty for 2022? a. 350,000 b. 100,000 c. 175,000 d. 150,000 What amount should be reported as estimated warranty liability on December 31, 2022? a. 150,000 b. 250,000 c. 125,000 d. 0 . What amount should be reported as warranty expense for 2023? 300,000 350,000 490,000 140,000 Bore What amount should be reported as estimated warranty liability on December 31, 2023? 390,000 440,000 490,000 840,000 Boop 90Problem 3-16 (AICPA Adapted) During 2022, Namnama Company introduced a new product carrying a two-year warranty against defects, The estimated warranty costs related to peso sales are 4% within 12 months following sale and 6% in the second 12 months following sale, The entity reported sales of P5,000,000 for 2022 and P6,000,000 for 2023. The actual expenditures incurred amounted to P150,000 for 2022 and P550,000 for 2023. 1. What amount should be reported as warranty expense for 2022? 500,000 200,000 250,000 300,000 poop 2. What amount should be reported as estimated warranty liability on December 31, 2022? a. 350,000 b. 150,000 c. 100,000 d. 50,000 3. What amount should be reported as warranty expense for 2023? a. 650,000 b. 600,000 ¢. 500,000 d. 550,000 4. What amount should be reported as estimated warranty liability on December 31, 2023? a. 360,000 b. 400,000 c. 240,000 d. 100,000 91Problem 3-17 (PHILCPA Adapted) 22, The entity sells Cyprus Company started business in 20: i and estimated its printers with a three-year warranty warranty cost as a percentage of peso sales. it is estimated that 3% will be 5% will be repaired 0% will be repaired Based on past experience, repaired during the first year of warranty, during the second year of warranty and 1 in the third year of warranty. In 2022 and 2023, the entity was able to sell 7,500 units and 10,000 units, respectively at P4,000 per unit. of P800,000 and The entity incurred actual repair cost A Sales and repairs P2,400,000 in 2022 and 2023, respectively. occurred evenly throughout the period. 1. What amount was recorded as estimated warranty liability on December 31, 2023? a. 5,400,000 b. 7,200,000 c. 9,400,000 d. 4,800,000 2, After testing the adequacy of the warranty cost, what amount should be reported as estimated warranty liability on December 31, 2023? 9,675,000 9,600,000 9,300,000 8,100,000 BS op 3. What amount should be reported as adjusted warranty expense for 2023? 7,200,000 7,475,000 6,925,000 7,400,000 aeop 92Problem 3-18 Multiple choice (IAA) 1 wp Py ~ Ld The accrual approach in accounting for warranty a. Is required for income tax reporting. b. Is frequently justified on the basis of expediency. ¢. Finds the expense account being charged when the seller performs in compliance with the warranty. d. Should be used whenever the warranty is an integral and inseparable part of the sale. . Which of the following best describes the accrual approach of accounting for warranty cost? Expensed when paid Expensed when warranty claims are certain Expensed based on estimate in year of sale Expensed when incurred peop . Which of the following best describes the expense as incurred approach of accounting for warranty cost? a. Expensed based on estimate in year of sale b. Expensed when liability is accrued : c. Expensed when warranty claims are certain d. Expensed when incurred What is the classification of the estimated warranty liability in a three-year warranty? a. Noncurrent b. Current c. Partly current and partly noncurrent d. No need for disclosure Which of the following is a characteristic of the accrual of warranty but not the sale of warranty? Warranty liability Warranty expense Unearned warranty revenue Warranty revenue BP op 93