Warranty definition
/What is a Warranty?
A warranty is a guarantee related to the performance of non-financial assets that are owned by the party being guaranteed. A guarantee is frequently incurred in connection with the sale of goods or services to the party being guaranteed. If the warranty is related to a product, the party providing the guarantee normally replaces or repairs the product in question. If the warranty is related to a service, the party providing the guarantee usually provides a full or partial refund, or replacement services.
Many manufacturers view the sale of a warranty as a major source of revenue, for two reasons. First, the price at which it is sold usually greatly exceeds the associated cost. And second, many customers forget that they have a warranty, and so never file any claims against the manufacturer.
How to Account for a Warranty
A warranty is a contingent liability, so the party providing it should record a liability and warranty expense when it records the associated sale of goods or services. As the selling party incurs actual warranty costs, it charges them against the liability account, which therefore declines over time. If there is a history of minimal warranty expenditures, there is no need to record a contingent liability in advance of actual warranty expenses.