When should a product warranty liability be recorded?

When should a product warranty liability be recorded?

The problem of recording the warranty liability is an important accounting principle and weights
considerably in the organization of the regular financial report.

The warranties are usually offered as a guarantee that products with problems will be replaced or
repaired, free of charge. The period covered may differ from a couple of months to several years. In the
case of a car, the warranty may cover several years, while for a camera, the maximum period covered is
12 months. The warranty may be offered on the basis of several justificatory documents, and should be
included in the original contract signed on the occasion of the purchase. In many situations, the amount
of interventions allowed by the warranty certificate may be limited and justified by the appropriate
technical expertise. For example, you may not be able to change a product every 3 months.

Recording methodologies

A product warranty liability and warranty expense should be recorded at the time the product is sold, if it
is probable that customers will be making claims under the warranty and the amount can be estimated.
Thus, it is very important to be able to calculate carefully the value of the warranty. The value of the
warranty may be calculated in function of the history of the product or any other specific data regarding
the specific asset.

These two conditions are part of the FASB’s Statement of Financial Accounting Standards No. 5,
Accounting for Contingencies. You can read this pronouncement, which includes a discussion of product
warranties, at: www.FASB.org/st.

When the warranty liability is both probable and can be estimated, it is more likely that the accountant
will accrue during the period of the sale a liability and an expense for the future warranty work. This
matching of warranty expense with the related sales revenue is reasonable, since the warranty could be
as important in getting the sale as the product’s advertising expense.

Experts in the domain of accounting are recommending that the section dedicated to register the various
warranty claims should be split into two parts: for current and long-term types of warranties. The criteria
for this delimitation resides in the period of time that are expected to include the expenses for covering
the warranty.

When the warranty liability is reduced

When work is done under the warranty coverage, the warranty liability will be reduced. To illustrate,
assume that an automobile manufacturer debits in the category ‘Warranty Expense’ for the amount of
$1,000 and credits the category ‘Warranty Liability’ in the amount of $1,000 in the period that a car is
sold. When the car needs a $400 repair under the warranty, the manufacturer will reduce the amount
included in the category ‘Warranty Liability’ by debiting the account for $400. In the same time, another
account, such as Cash, will be credited for the $400 it remits to the dealer that performed the repair
work. This will leave a liability of $600 for additional repairs during the remainder of the warranty period.

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What are the principles of accounting?

What are the principles of accounting?

The familiarity with the principles of accounting may be a matter of interest not only among those
who are directly involved in the daily practice of working with accounting principles on a daily basis.
The possibility of understanding the main ideas of these principles may be part of an introductory class
for everyone connected at a certain level with a company. Thus, we will be able to understand how
connected we are, in fact, with the various daily accounting practices.

For example, your monthly salary is paid as part of a complex accounting operation and the same is
available in the case of the price paid for the computer you use on a regular basis or the price of the
electricity each of you is using for covering current technical needs of the company.

You may also be aware of the fact that, from a country to another and from a type of business to
another, the practical applications of the principles of accounting may differ. Thus, even if you are not a
professional that may need to know in detail the legal provisions on accounting, it is still useful to have
an insight regarding the most important meaning of the term ‘accounting’.

Three meanings for the same expression

Three meanings come to mind when you think about the basic principles of accounting:

1. The term ‘Principles of Accounting’ were often used as the title of the introductory course in
accounting. It was also common for the textbook used in the course to be entitled Principles of
Accounting and it is aimed to offer to various readers the basic information regarding how to operate
and perform various accounting operations. You can find various online platforms where you can learn
more about the principles of accounting, in virtual classrooms or using various online interactive tools.

2. Principles of accounting can also refer to the basic or fundamental accounting principles. Thus, the
main terms that you will use are: cost, matching, full disclosure, materiality, going concern, economic
entity, and so on.

In this context, the expression ‘principles of accounting’ refers to the broad underlying concepts which
guide accountants when preparing financial statements.

3. Principles of accounting can also refer to generally accepted accounting principles (GAAP). When used
in this context, principles of accounting will include both the underlying basic accounting principles and
the official accounting pronouncements issued by the Financial Accounting Standards Board (FASB) and
its predecessor organizations. The official pronouncements are detailed rules or standards for specific
topics.

In general, the principles of accounting are applied by professionals with a long practical experience. In
many cases, they need to pass exams at the end of which they will be officially qualified as experts in the
domain of accounting. This qualification is usually acquired at the end of at least one year of intensive
learning with qualified accounting experts. It may be long and it may be difficult, but as a qualified
accountant you will rarely complain of scarcity of working opportunities.

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What is the difference between revenue, income, and gain?

What is the difference between revenue, income, and gain?

Terms as revenue, income and gain are frequently appearing in the everyday financial vocabulary. But
do we always know what we are referring to when using them? The three terms are usually used as
equivalents in the daily language, but we will try to explain that this is not a correct affirmation.

In the following article we will try to shed some light on those terms aiming to offer a better
understanding of their significance for a large category of readers.

The classification between the terms, but especially between revenue and gain can produce general
effects on the ways in which various transactions are classified, with consequences on the classifications
of the income statements.

What is revenue?

Revenue represents the amount earned from a company’s main activities such as selling merchandise or
providing services. The value of the revenue may increase during the daily activities of a certain company
or business. It is also correct to include in the category of revenue the gross value of sales.

For example, the revenue of a university is increasing by the payment of the tuition fee, or the revenue
of a bank increase by the payment of various loans.

What is gain?

Unlike the revenue, the gain represents the value of an income that is not obtained during the regular
activities of a certain company or business. The gain may also refer to the amount of excess of selling
price or the fair value of an asset.

For example, the gain resulted from a peripheral activity, such as selling the old delivery truck. The gain
is the amount received that is in excess of the asset’s carrying amount (book value). For example, if the
company receives $3,000 for the truck, and its carrying amount was $600, the company will report a gain
of $2,400.

What is income?

Income is sometimes used instead of the word revenue: some people refer to the rent they receive as
rent income. The sense of the term may cover both revenue and gain. Generally, accountants use the
word income as the meaning of the expression “net of revenues and expenses.” For example, a retailer’s
income from operations is sales minus the cost of goods sold minus operating expenses.

The level of the income may result in an inflow or increase of assets and equities. When the revenue
grows, the level of liabilities decreases as well.

There are several activities that may produce valuable income, among which we will mention: the use
of various financial resources as, for example, the price obtained from rents or royalties; the various
sales of goods for various categories of customers; the gain obtained following various foreign exchange
operations; the gain on sales of investments.

Knowing the meaning of those three terms is very important for the way in which we are structuring
the financial report and the regular accounting reports as such. In case that you need more information
about the correct classification of an operation, you should ask the opinion of a qualified expert.

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