A warranty is a guarantee that a company will replace or fix a defective item it sells to a customer. You can calculate a warranty reserve liability and record it in your accounting records to reflect the amount you expect to pay for warranties in the future. You must record a warranty expense in the accounting period in which you sold the items and create a liability for the same amount. You can reduce or draw down your warranty liability account in the future when you perform warranty service.
Divide the amount of your actual warranty claims in the most recent year by your total sales in the same year to calculate your warranty claims as a percentage of sales. For example, if you had $1,600 in warranty claims and $80,000 in sales, divide $1,600 by $80,000. This equals 0.02, which is equivalent to 2 percent of your sales.
Multiply your warranty claim percentage by the amount of your sales in the current year to calculate your warranty reserve liability for the current year. For example, if you generated $100,000 in sales for the current year, multiply $100,000 by 0.02. This equals a $2,000 warranty reserve liability for the current year.
Record a warranty expense in your accounting records for the amount of your warranty reserve liability. For example, record a warranty expense of $2,000.
Add your warranty reserve liability for the current year to the balance of your warranty reserve liability account at the beginning of the year. For example, if your beginning balance is $1,000, add your warranty reserve liability for the current year of $2,000 to $1,000. This equals $3,000.
Subtract the amount of any warranty service work performed during the year from your warranty reserve liability account balance to calculate your year-end balance. For example, if you performed $250 of warranty service work during the year, subtract $250 from $3,000. This equals a year-end warranty reserve liability account balance of $2,750.