Following the meeting we held with you recently, I take this opportunity to give my findings and recommendations concerning Accounting for warranty programs. I have conducted a research to determine what is them best approach the company, analyst the finding of my research, and using my analysis I strongly believe that am in a position to advice on the best way of handling and accounting for the warranties.
The most important thing which FSC should comply with is observation of accounting principles. There several accounting principles which are equally important, but for the case of FSC the most crucial ones are; cost principle and Revenue principle. This is due to the fact for any business to exist and remain in business it must looks on means of reducing the cost and maximizing the revenue.
Fuzz and Static Company being in a manufacturing industry, it provides warranty for its customers. According to the records FSC provides warranty in two categories. First customers are offered basic warranty which is for one year, then they are given option of extending warranty of another one year. FSC has employed this approach to satisfy its customers which is a good approach provided all factors are considered.
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According to Financial Accounting Standard Board (FASB) statements of financial accounting standards number five, a product warranty liability and warranty expenses should be recorded after selling a product, if there is high possibility of customer to make claims under the warranty and amount can be estimated. When these two principles are met an accountant will be in a position to accrue during the period of sale a liability and expense for the future warranty provision. This is very important because it minimizes chances of the company over granting warranties.
According to Mr. Elmaleh M. S. in his article of “accounting for product warranties” the fundamental concept of accrual accounting is that revenues are documented when the earnings process is complete and not necessarily when goods or service are paid for. In the case of Fuzz and Static Company it offers warranty to its customer immediately when they purchase cell phone. FSC has even gone miles ahead and offered extended warranty to its customer which begins after the basic warranty. This a very important step which can benefit both FSC and the customers, however accounting for these services is very crucial and proper mechanism should be put in place to ensure that customers are protected and company over spent on this.
According to the records FSC in the year 2009 sold 4200 cell phone at price of $ 140 each giving a total of $ 588,000. it is recorded that out of $ 588,000, $ 9,400 was accounted for the service of warranty claims under basic warranty claim. This means the percentage of the total amount which was for basic warranty is 15.97% this is a reasonable ratio, although it suspected that this amount might increase in the year 2010. In a more realistic aspect and one which is authorized by General accepted accounting principles (GAAP) is to allows company offering the warranty to make reasonable estimate of the costs meeting product warranties and acknowledges these warranty cost sales are made.
FSC should be in a position to estimate the ratio of expected claims after sale, and use the estimate to determine the warranty ratio. For example FSC in its program of extended warranty, it sold 1200 warranties and there were no claims which came for this service. Though this can’t always be the case but from economic perspective FSC has benefited from this program and it is highly recommendable to carry it on.
From the perspective of accounting and as an expert in accounting, is my pleasure to advice FSC to compare variables such as useful live of the cell phone to determine depreciation rate of the phones. This approach will give FSC better chances of knowing how to allocate warranty services because warranty service can be wildly hard to anticipate. It is a fact that anticipated warranty expenses can’t be exact to the estimation, especially with the continuing innovation because established product doesn’t offer good guidance of accounting for warranty.
In conclusion, it is a common practice for businesses to offer assurance and repair for the product, replacement of failing part or eve refund incase of customer dissatisfaction they sell. Therefore FSC should evaluate all possible outcome of every available option of providing warranty and go for the most economical option.