Extended Warranty Accounting

Our tutorial on warranty costs discussed the situation where a business makes a sale to a customer and includes in the product purchase price a standard warranty, which allows the customer to have the product repaired or replaced if it is found to be defective within a certain period of time.

In addition to the standard warranty, businesses often sell a separate extended warranty for an additional fee allowing the customer to have the product repaired or replaced if for example, it is found to be damaged or defective after the original standard warranty has expired. In essence, the customer has purchased a separate insurance policy for the product.

As the extended warranty is for a period of time in the future, revenue from the sale is initially unearned and is therefore deferred and recognized over the period covered by the extended warranty.

In accordance with the matching principle as the revenue is deferred no costs are accrued at the inception of the extended warranty agreement. (This is in contrast to the standard warranty given as part of the purchase price of the product where the revenue is not deferred and the contingent liability for warranty costs is immediately recognized and matched to the revenue).

Extended Warranty Accounting Treatment

Suppose a business sells an extended warranty with a term of four years for an additional fee of 80. In this example, the extended warranty does not become active until the standard warranty has expired in a years time. The fee is not yet earned as the services are to be provided over the four year period which starts in one years time, and the extended warranty fee is entered into the accounting records of the business with the following accounting journal.

Extended warranty accounting journal entry
Account Debit Credit
Cash 80
Unearned revenue 80
Total 80 80

The balance on the unearned revenue account is a liability of the business, as it has an obligation to provide services to a customer at some future date over the term of the extended warranty agreement.

Extended Warranty Revenue Recognition

When the standard warranty expires (one year after the product sale), the extended warranty becomes active for a term of four years. At the end of each of those years one quarter of the fee revenue (20) can be treated as earned, and the following mdct.ru journal is entered:

Extended warranty fee journal entry
Account Debit Credit
Unearned revenue 20
Extended warranty fees 20
Total 20 20

Extended Warranty Costs

Each year warranty costs to repair and replace defective and damaged products will be incurred and, as the revenue has now been recognized, the warranty costs need to be matched to the revenue earned and shown as expenses in the income statement.

Suppose in the above example warranty costs of 16 has been incurred during the first year of the extended warranty term, then the bookkeeping journal to record this entry is as follows:

Extended warranty costs incurred journal entry
Account Debit Credit
Warranty expenses 16
Cash 16
Total 16 16
Extended Warranty Accounting November 6th, 2016Team

You May Also Like

Related pages

capital bookkeepingasset turnover ratiosoverhead variance definitionlifo periodic and perpetualcontribution margin variable costcall option accounting journal entriescommon size income statement calculationamortize bondstraight line depreciation templateclosing retained earningsperpetual system journal entriesaccrual bookinghow to calculate assets liabilities and equitysales mix exampleformula for total fixed costwhat is a suspense account on balance sheetconvert markup to marginhow do you calculate asset turnoverjournal entry for machinery purchaseunearned rent revenueinvested capital turnoveraccounting equation spreadsheetavailable for sale securities exampleis merchandise inventory a current assetrate of return calculator excelamortization straight line methodwhat is accrued expenses in accountingcreditor definition in accountingpurchase of marketable securitiescash discount examplehow to record closing entrieseir accountingjoint venture accountantcontribution margin income statement templatepayment voucher templateshow to do vertical analysis of income statementeffective interest method formulasimple bookkeeping templatehow to find future value of annuityprepaid rental incomelifo formulaaccounting equation templateaccounting for goodwill journal entriesreducing balance loan calculator excel downloadannuity due payment formulaannuity due calculator future valueexample of absorption costingprepaid rent adjusting entrycalculate future value of an annuitycompounded continuously examplescurrent liabilities equationexample general ledgerwhat does fob in shipping meancalculate variable costhow to calculate the present value of an annuityfactoring trade receivablesaccrual entriesaccounting objectivity principlecommon bookkeeping entriesjournal entry for issuing stockdouble entry bookkeeping systemdupont financial analysisreturn on equity dupontaccounts receivable templatetreatment of deferred tax in profit and loss accountfinance lease receivableamortization chart excelexpense reconciliation templatehow to calculate gp marginunits of production depreciation formulaaccumulated depreciation asset or liabilityhow to calculate operating profit margin ratiopresent value of annuity factoran example of deferred revenue is unearned rentmargin and markup formulahow to calculate depreciation with salvage valueaverage accounts receivable turnover