Question

Every new iPhone comes with a basic one-year warranty. If defects in materials or workmanship are discovered in one year from the date of retail purchase, Apple will repair or replace the iPhone at no cost to the customer. Recently, a batch of iPhone 6s devices was discovered to have a defect that causes them to shut down unexpectedly when the battery charge level reaches about 30%. Apple has issued a battery replacement program for these iPhone 6s devices.

Questions

1. Assume that Apple makes a quarterly adjusting entry using the percent-of-sales method to estimate warranty expense for all new iPhones sold during the quarter. How will this adjusting entry impact Apple’s balance sheet? Its income statement?

2. Is the adjusting entry for warranty expense an accrual or a deferral? Explain.

3. Now think about the battery replacement program for the affected iPhone 6s devices. When a customer brings in his/her iPhone 6s for a battery replacement under the battery replacement program, how will this transaction impact Apple’s balance sheet? Its income statement?

Answer 1

Answer-1:

Warranty expense is accrued with a debit to the warranty expense account and a credit to the warranty liability account.

As and when sale is recorded,  the income statement is impacted by the full amount of warranty expense, even if there are no warranty claims in that period. Balance sheet is also impacted with the same amount on its liability side.

Answer-2:

The adjusting entry for warranty expense is an accrual.

When a company provides a warranty with its product, the company has an obligation to repair or replace the product if it is defective. That obligation generates a liability at the time the product is sold because the company has a liability that starts when the product is sold.

Hence, the company can not defer this liability to a later period.

Answer-3:

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.

As claims appear in later accounting periods, the only subsequent impact is on the balance sheet, as the warranty liability and inventory accounts are both reduced. Income statement is not impacted with this.