Assurance warranty approach

An assurance-type warranty only promises that the product will work as intended and isn’t sold separately. A service-type warranty is a separate performance obligation: a warranty is service-type if the customer can purchase it separately, or if it provides a service beyond that assurance (such as extended coverage), even when it’s bundled with the product. That distinction decides which accounting model applies.

Journal entry at the time of sale

At the time of sale, the full transaction price is recognized as sales revenue - none of it is set aside as unearned warranty revenue, because the warranty is not a separate performance obligation. There is also no later revenue-recognition entry as a performance obligation is satisfied, since there’s no separate performance obligation to satisfy. The sale entry is as follows:

• Debit cash or accounts receivable: XXX
• Credit sales revenue: XXX

This contrasts with the service-type warranty approach, where part of the transaction price is deferred as unearned warranty revenue and recognized over the coverage period.

This is common for warranties that cannot be purchased or negotiated separately because these only provide assurance that the goods will function as intended.

Journal entry for estimated warranty expenses

Assurance-type warranties are accounted for as loss contingencies under ASC 450 (warranty scope guidance sits in ASC 460), recognized when both of the following are true:

• the loss is probable, and
• the amount can be reasonably estimated.

The warranty is recorded as warranty expense and a liability on the balance sheet at the time of sale, using a reasonable estimate of the cost to repair or replace a defective good or service.

In the CMA exams the calculation of the estimated cost of the warranty can be a straight-forward calculation using:

• a percentage of sales
• warranty cost per unit sold, or
• any other manner of calculation.

No matter what approach is used, we should determine the total warranty liability for all future periods covered by the warranty. This approach results in a warranty liability that may have a current or non-current portion depending on the period covered by the assurance type warranty.

The journal entry is as follows:

Account	Debit	Credit	Financial statement element
Warranty expense - assurance type	XXX		Expense
Estimated warranty liability - current		XXX	Liability
Estimated warranty liability - non-current		XXX	Liability
To record estimated warranty costs under an assurance type warranty

The current portion is the estimated cost expected to be paid within one year of the balance sheet date. The non-current portion is the expected cost to be paid beyond one year.

This estimation process is not performed under the service-type warranty approach.

Journal entry for the actual costs of providing the warranty

Since the loss (with income statement impact) has already been recorded in the estimation process, a warranty claim only reduces the liability account. The entry is as follows:

Account	Debit	Credit	Financial statement element
Estimated warranty liability	XXX		Liability
Cash		XXX	Asset
To record costs incurred related to fulfilling the assurance type warranty

Under the service warranty approach, this journal entry has a debit to the warranty expense account.

Example: recording the sale-related warranty entries

Riverside Co. sells appliances with a two-year assurance-type warranty and estimates warranty costs at 2% of warranty-eligible sales of $500,000, or $10,000. It expects $9,000 of that liability to be paid within a year and $1,000 beyond a year.

Estimation entry:

• Debit warranty expense - assurance type: $10,000
• Credit estimated warranty liability - current: $9,000
• Credit estimated warranty liability - non-current: $1,000

Riverside later pays $6,000 cash on warranty claims.

Claim entry:

• Debit estimated warranty liability: $6,000
• Credit cash: $6,000

Key point: The claim entry has no income statement effect - the $10,000 expense was already recognized at the time of sale.

Year-end procedures

For assurance-type warranties, year-end procedures are important to evaluate the balance of the liability for estimated warranty liability at the end of the period. The company should assess the following:

Determination of expired warranties still in liability

The liabilities related to expired warranties at the end of the period should be removed by reversing the journal entry in the estimation process. This removal is a change in accounting estimate, not a separate accounting model - it runs through the same warranty expense account as the original accrual, just in reverse:

Account	Debit	Credit	Financial statement element
Estimated warranty liability	XXX		Liability
Warranty expense - assurance type		XXX	Expense
To record reversal of remaining liabilities from expired warranties

Assessment of the warranty liability ending balance

Determine if the year-end balance of the estimated warranty liability based on the facts and circumstances is appropriate. If the liability is not enough, we should record additional warranty expenses and if the liability is too high, a reversal should be recorded like in the previous journal entry.

Exam tip: CMA exam candidates should also be able to compute the ending balance of the warranty liability. The pro forma calculation below follows the debit and credit convention - remember that the normal balance of a warranty liability is a credit.

Continuing the Riverside Co. example: assume a beginning balance of $8,000 and $1,000 of expired, unclaimed coverage at year-end. Combined with the $10,000 expense and $6,000 of claims above:

Warranty liability, beginning balance	$8,000
Warranty expense (as calculated)	$10,000
Warranty claims	($6,000)
Expired warranty	($1,000)
Warranty liability, ending balance	$11,000

The $1,000 expired-coverage reversal credits warranty expense, so Riverside’s net warranty expense for the year is $9,000 ($10,000 − $1,000).