ASC 450 Contingencies: Warranty Liability Transaction Explained with Journal Entries
Posted In | ASC Education | Gridlex AcademyThe ASC 450 accounting standard, established by the Financial Accounting Standards Board (FASB), provides guidance on the accounting for contingencies, such as warranty liabilities. In this article, we will provide an overview of warranty liability accounting under ASC 450 and illustrate how journal entries can be used to account for transactions involving warranty liabilities.
Warranty Liability Accounting under ASC 450
A warranty liability arises when a company provides a warranty to its customers, agreeing to repair or replace defective products within a specified period. Under ASC 450, companies are required to estimate and recognize a warranty liability at the time of the product sale. The estimation of warranty liabilities is typically based on historical data, such as past warranty claims and repair or replacement costs.
Journal Entries for Warranty Liability Transactions
To illustrate the concept of warranty liability accounting under ASC 450, let's consider a simplified example involving a company that sells products with a one-year warranty.
1. Record the product sale
The company sells a product for $10,000. The journal entry to record the sale is as follows:
Debit: Accounts Receivable - $10,000
Credit: Sales Revenue - $10,000
2. Estimate and record the warranty liability
Based on historical data, the company estimates that warranty costs will amount to 2% of sales revenue. The journal entry to record the estimated warranty liability is as follows:
Debit: Warranty Expense - $200 (2% of $10,000)
Credit: Warranty Liability - $200
3. Record a warranty claim and the related costs
During the warranty period, the company receives a warranty claim and incurs $150 in repair costs. The journal entry to record the warranty claim and the related costs is as follows:
Debit: Warranty Liability - $150
Credit: Inventory or Accounts Payable (depending on whether the repair involves parts or labor) - $150
4. Adjust the warranty liability at the end of the reporting period
At the end of the reporting period, the company reviews its warranty liability estimates and determines that the actual warranty costs were lower than initially estimated. The company needs to adjust the warranty liability balance to reflect the actual costs. Assume the remaining warranty liability balance is $30. The journal entry to adjust the warranty liability is as follows:
Debit: Warranty Liability - $20
Credit: Warranty Expense - $20
The ASC 450 standard requires companies to estimate and recognize warranty liabilities at the time of the product sale. By understanding the concept of warranty liability accounting and properly accounting for transactions involving warranty liabilities through journal entries, organizations can maintain accurate financial reporting and compliance with ASC 450. As businesses continue to navigate the complexities of contingency accounting, it is essential to invest in the right tools and resources, such as advanced accounting software, to streamline the process and ensure ongoing compliance.