Question

Greg Johnson, after completing the adjusting for his new company, Poly-Fix, was called to meet with the company controller to discuss his proposed entries. Greg assumed that the controller was questioning his efforts as he was asked to bring his notes, calculations, and supporting documentation. He soon learned that his assumption was incorrect and that his boss wanted him to reconsider one of the adjusting entries for an estimated expense.

Poly-Fix is a new company, specializing in commercial fasteners. Their products have a long-term warranty against manufacturing defects. Greg's boss feels that 3 percent of sales is too high for their warranty expense estimate. This is a new product that has yet to be tested, and the company president is under pressure from their lenders to meet projected income and profit levels.

• Why should a company accrue warranty expense? Explain.

Answer 1

A company should accrue warranty expenses so as to be able to reflect cost of anticipated warranty claims. This is an accounting requirement under the matching principle. Companies often have a warranty policy on the products being sold by them and the warranty may be to repair or replace the goods when certain type of damages or defects is present in the product.

Thus as per the concept of matching principle a company has to match the revenues that it has earned from the goods sold to the warranty expenses associated with it. It should be noted that to accrue warranty expenses a company should be able to reasonably estimate the amount of warranty claims that are likely to arise during a period.

Thus a company should accrue warranty expenses in order to ensure that its financial statements accurately reflect all costs that are associated with product sales and that true profitability is presented in its financial statements.