How to Account for Warranty Costs in Journal Entries
The journal entries for the sale of machinery, warranty accrual, and warranty costs incurred are as follows:
(a) Sale of machinery and warranty expense incurred:
Debit: Accounts Receivable - Alvarado Company
Credit: Sales Revenue - Alvarado Company
Debit: Cost of Goods Sold - Inventory
Credit: Inventory - Alvarado Company
Debit: Warranty Expense
Credit: Inventory - Alvarado Company
(b) Warranty accrual:
Debit: Warranty Expense
Credit: Warranty Liability - Alvarado Company
(c) Warranty costs incurred:
Debit: Warranty Liability - Alvarado Company
Credit: Inventory - Alvarado Company
(d) Liability for future warranty costs:
A liability of $117,000 ($390 per machine × 300 machines) would be disclosed in the Balance Sheet as a liability for future warranty costs.
When a company sells machines with a warranty agreement, it is important to properly account for warranty costs in journal entries. The journal entries for these transactions are crucial in ensuring accurate financial reporting.
Sale of machinery and warranty expense incurred:
When a machine is sold with a warranty agreement, the company must recognize the sale and the warranty expense. The Accounts Receivable account is debited for the amount owed by the customer, while Sales Revenue is credited for the total sales amount. Cost of Goods Sold is debited for the cost of the machine, and Inventory is credited to reduce the inventory on hand. Additionally, the Warranty Expense account is debited to recognize the estimated cost of warranty repairs.
Warranty accrual:
As the company incurs warranty expenses, it must accrue for these costs by debiting the Warranty Expense account. The corresponding credit is made to the Warranty Liability account, which represents the amount the company expects to pay out in future warranty claims.
Warranty costs incurred:
When actual warranty costs are incurred, the company debits the Warranty Liability account to reduce the liability and credits the Inventory account to reflect the cost of the warranty repairs.
Liability for future warranty costs:
The balance sheet will show a liability for future warranty costs, which is calculated based on the estimated warranty cost per machine multiplied by the number of machines sold. In this case, the liability for future warranty costs is $117,000.