Question

If the Estimated Warranty Liability account has a debit balance throughout the entire year, what does that mean about the accruals being done?
If the account has a debit balance at the end of the year, is retained earnings going to be over- or under-stated? Why?

Answer 1

When a company provides a warranty with its product, the company has an obligation to repair or replace the product if it is defective. That obligation generates a liability at the time the product is sold because the company has a liability that starts when the product is sold

The matching principle states that a company must match revenue with expenses. The warranty expense occurs because the sale took place. The expense is a cost of the sale and therefore should be matched with the revenue generated by that sale

Warranty expense should be recorded by the company based on the percentage of number of defectives items based on past performance. We need to create a provision for warranty expense.

Journal entry :

Account Debit Credit

Warranty Expense A/c    x

Estimated warranty Liability x

Estimated warranty liability is to be showing the credit balance, if the company has warranty policy

If Estimated warranty Liability account shows debit balance it means showing asset balance. This situaton could be arises if there is over estimation of Warranty Liabilty in Earlier years. therefore we need to reverse this liabily in current year. Consequently there may be a debit balance in Estimated warranty liability account.

Impact on Retained earnings :

If Estimated warranty Liability account shows debit balance, there may be under estimation of Retained earnings in earlier years. Because We booked excess expenditure in earlier years, automatically the net profit decrease and retained earnings also decreases