What is Warranty expense?
Warranty expense is defined as the cost of repairing, replacing, or compensating a user for any product defects.
A warranty is a contractual period that specifies the conditions under which the vendor or producer will repair, replace, or compensate for a defective item at no cost to the buyer or user. Each warranty has a ‘warranty period’ that defines the time frame during which the vendor or producer is required to repair, replace or compensate for the defective product. When a product’s warranty period expires, the vendor or manufacturer is no longer liable for any defects.
Warranty expense is defined as the cost of repairing, replacing, or compensating a consumer for any product defects under the warranty period. To comply with the matching principle, the expense should be reported on the income statement at the same time as the product sale. At the time of the sale, a related account, Warranty Payable or Warranty Liability, is also established.
Recording Warranty Expense in the Financial Statements
When a product is sold to a customer, the company will debit (charge) the warranty expense account and credit (accrue) a liability account in the financial statements.
If the product is defective and must be replaced, the company will reduce both the liability and inventory accounts because the replacement product will be issued from its inventory. If the defective product must be repaired or refunded, the expense is deducted from the liability account.
If there is a likelihood that an expense will be incurred and the company can estimate the amount of the expense, warranty expense is recognized in the same period as revenue for the sold products.