Reference no: EM132437872

Question - Factoring in Warranty Liability

A warranty is another common contingent liability because the number of products returned under a warranty is unknown. Assume, for example, that a bike manufacturer offers a three-year warranty on bicycle seats, which cost $50 each. If the firm manufactures 1,000 bicycle seats in a year and offers a warranty per seat, the firm needs to estimate the number of seats that may be returned under warranty each year. If, for example, the company forecasts that 200 seats must be replaced under warranty at a cost of $50, the firm posts a debit (increase) to warranty expense for $10,000 and a credit (increase) to accrued warranty liability for $10,000. At the end of the year, the accounts are adjusted for the actual warranty expense incurred.

What about a situation where the bike company either overestimates, or underestimates the warranty claims? How would they account for these situations?