At the end of the accounting period, the company will show an existing liability for the warranty costs it estimates to make in future years to customers it has sold products. Supplies and labor required to honor this service agreement are recorded when service is provided to a customer. The accountant would not try to go back and correct this estimate if it proves to be wrong instead the accountant merely watches the estimates and actual service costs and adjusts future estimates accordingly.
Example Estimated Warranty Liability Problem:
During 2004, A Small Business Hardware company introduces a new product carrying a two-year warrranty. The estimated warranty costs are 4% of dollar sales. Sales and actual warranty expenditures for the years ended December 31, 2004 and 2005 follows:
Sales Actual Warranty expense
2004 $ 800,000 $21,000
2005 $ 1,000,000 $31,000
Set up a T-account for Estimated Warranty Liability:
24000 | 32000
30000 | 40000
The 24000 and 30000 are the actual amount of money that the hardware company used to repair the stuff and the 32000 and 40000 are found by multiplying the 4% by the sales for that year, which is the Estimated warranty liability, or the amount of money the hardware company estimates that it will need to repair the hardware product. So the company is subtracting the "actual" money used for the amount of money the company estimated it would use.
Additional Accounting Examples:
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