Journal entry for warranty expense
Introduction
In accounting, we usually need to make the provision and record the warranty that we give to the customers with the purchased products as a warranty expense. Likewise, we usually need to make the journal entry for warranty expense at the period-end adjusting entry in order to account for the expense that is likely to happen as well as to record the liability obligation that we need to fulfill in the future.
The warranty that we give to the customer is a type of contingent liability that we usually need to make the provision for. This is due to we usually can reasonably estimate this type of contingent liability and it is probable the warranty expense will occur considering we may sell hundreds, thousands, or ten thousand of goods, during each accounting period.
We usually need to make the journal entry for the warranty expense at the period-end adjusting entry in order to match the expense that is likely to occur from the warranty with the revenue that we generate from the sale. And the provision for this contingent liability is to record the expense that should match the time that the revenue earned as well as to recognize the liability that we owe to the customer for the warranty.
Likewise, without making a proper provision for the warranty that we give to the customers, there may be an understatement of liabilities on the balance sheet as well as an understatement of expenses on the income statement.
Journal entry for warranty expense
We can make the journal entry for warranty expense by debiting the warranty expense account and crediting the warranty payable account at the period-end adjusting entry.
| Account | Debit | Credit |
|---|---|---|
| Warranty expense | XXXX | |
| Warranty payable | XXXX |
In this journal entry, both total expenses on the income statement and total liabilities on the balance sheet increase by the same amount. Even though it may make our accounting record look worse, it is usually still necessary to make this journal entry in order to comply with the accounting rule.
After all, this journal entry is made to comply with the matching principle of the accounting, as we need to match the expense that could occur due to the warranty to the period that we generate the sales revenue.
Later, when the warranty which is a contingent liability is realized (e.g. when the customers bring back the goods to be repaired), we can make the journal entry in order to honor the warranty given by debiting the warranty payable account and crediting the inventory account as below:
| Account | Debit | Credit |
|---|---|---|
| Warranty payable | XXXX | |
| Inventory | XXXX |
This journal entry is made when we honor the warranty contract, by repairing the broken goods or replacing the defective products. Likewise, if the proper estimation is made when we make the provision for the warranty above, the total cost of honoring the warranty contract during the period will be close to the amount of the warrant expense that we have recorded for the period.
Warranty expense example
For example, in our company, we give a one-year warranty on all types of products to the customers that purchase our products. The warranty given is that we will repair the purchased products by replacing the repair parts for free during the warranty period.
On December 31, we have made a total sales of $500,000 from 1,000 units of products sold during the year. We expect that 30 products which are equivalent to 3% of products sold will be returned for the repair service during the warranty period. And we expect to incur $20 per unit for the repair parts replacement.
Later, in January, there are 3 products that are still in the warranty period have been returned for repair. And as promised, we repair them by replacing 3 repair parts that cost $20 each in our inventory parts for free.
In this case, on December 31, we can estimate that the provision for the warranty expense for the period will be as below:
Warranty expense = 30 products x $20 per product = $600
In this case, we can make the journal entry for warranty expense by debiting the $600 into the warranty expense account and crediting the same amount to the warranty payable account in the December 31 adjusting entry as below:
| Account | Debit | Credit |
|---|---|---|
| Warranty expense | 600 | |
| Warranty payable | 600 |
Later, in January, we can make the journal entry for the $60 repair cost ($20 x 3) that we incur for honoring the warranty contract as below:
| Account | Debit | Credit |
|---|---|---|
| Warranty payable | 60 | |
| Inventory parts | 60 |
This journal entry is made when we honor the warranty contract that we have provided to the customers by repairing the products for free during the warranty period.
Estimate the provision for warranty expense
As mentioned, the warranty given to the customer is the type of contingent liability that we can usually make a reasonable estimation on the amount that be realized in each accounting period. The estimation is usually done with the past experiences that we have in our business.
Of course, if the industry data is available for us, we can also those data combine with our past experiences to make a more accurate estimation of the warranty expense that could occur in each accounting period.
For instance, in the example above, the 30 defective products which are equivalent to 3% of 1,000 units are usually determined based on past experiences. This is usually a reasonable estimation as the companies providing the warranty usually have sufficient past data to prove their estimation.
For example, companies usually have past data that show how many defective products are presented among thousands of products sold each year. Of course, new companies can use the available industry data for estimation and make any adjustments based on their own business.