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The key to proper revenue recognition for warranties is to first determine if the warranty provides a service to the customer beyond the required agreed-upon specifications. Next, the seller or company must allocate the price to both the product and separate warranty obligation based on standalone prices.

Warranties are recorded initially as a liability as it meets the definition of unearned revenue or deferred revenue. If the company charged $20 for a 2 warranty, that $20 would be collected at the time of sale. The warranty would then be recognized as revenue evenly over the 2 year period.

Warranty as a percentage of sales may vary from 0.5% to 5% of sales for different industries. This metric will help companies easily define the impact of warranty on company's bottom line.

Accrue the warranty expense with a debit to the warranty expense account and a credit to the warranty liability account. As actual warranty claims are received, debit the warranty liability account and credit the inventory account for the cost of the replacement parts and products sent to customers.

How to calculate warranty expenses Find the total number of products sold. ... Determine the percentage of defective products. ... Calculate the number of products needing replacement. ... Evaluate the cost of product replacement. ... Estimate the total warranty expense.

A product's warranty period can be established based on several factors, including: The industry standard for the product. What the competition is offering. The period of time during which some percentage of the products will still be functioning correctly.

This is How to Calculate Warranty Liability Costs Number Of Units (or Service Contracts Sold) Produced Per Period. Cost Per Unit. Expected Number of Warranty Claims in a Period. Use number as a percentage, i.e., 2% is 2. Cost Per Warranty Claim.