You have started working for a company that manufactures lawn mowers. These mowers carry a warranty that will replace defective parts for one year. The corporate president feels that an expense should be recorded when the defective parts are replaced. Explain the proper accounting treatment to the corporate president.
What will be an ideal response?
The matching principle requires businesses to record warranty expense in the same period the
company records the revenue from the sales of the lawn mowers. This means that the expense is
incurred when the sale is made, not when the company makes the warranty repairs. Because the exact
amount of the warranty expense is not known at the time of the sale, the company must estimate the
amount of expense. At the end of the accounting period, an adjusting entry is made to debit Warranty
Expense and credit Estimated Warranty Payable. Estimated Warranty Payable is a liability account that
appears on the balance sheet. When defective parts are replaced, the company will debit Estimated
Warranty Payable and credit Parts Inventory.
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