Question

How is estimating warranties similar or different from estimating uncollectibles for accounts receivables under allowance method?

Answer 1

You can look at your own historical data for warranty costs vs. sales to find a reasonable percentage of revenues that go to warrantied repairs and replacements. If you don't have historical data, use industry averages published by trade journals or industry websites.

Apply the percentage to your sales forecast for the upcoming period. For example, suppose you project $100,000 in sales for the next quarter. If you estimate that 1 percent of revenues will pay for warranty costs, multiply $100,000 by 0.01 to find the warranty liability of $1,000.

At the start of the accounting period, record the warranty liability. In this example, debit the warranty expense account and credit the warranty liability account for $1,000.

Acknowledge warranty costs as they occur. For example, if you must make a $75 warrantied repair on an item you sold, debit warranty liability and credit cash for $75

The warranty liability account appears in the "current liabilities" section of the balance sheet. However, if you offer warranty coverage that extends beyond a year, you need to split the warranty liability between the current and long-term liability sections of the balance sheet.

The estmation of warranties may differ from estimation of provision for baddebts