Question

Bellcom enters into a contract with a customer to sell a smart phone and provide a one-year warranty against both manufacturing defects and customer-inflicted damages (e.g. dropping the phone into water). The warranty cannot be purchased separately.

Required: How should Bellcom account for the warranty?

Answer 1

A business may have a warranty policy, under which it promises customers to repair or replace certain types of damage to its products within a certain number of days following the sale date. If the company can reasonably estimate the amount of warranty claims likely to arise under the policy, it should accrue an expense that reflects the cost of these anticipated claims.

The accrual should take place in the same reporting period in which the related product sales are recorded. By doing so, the financial statements most accurately represent all costs associated with product sales, and therefore indicate the true profitability associated with those sales.

Hence for provision of warranty following entry will be passed

Warranty expense

Provision for warranty