Warranty Expense Allocation & Study Methedology

CFA Level I FRA
#1

Hey all,

Matching Principle states that the company is obliged to estimate the future expenses resulting from warranties (in the period of the sale) and then update the expense as proved by experience.

  • So what happens if I sell phones, record an estimated warranty expense today, and after 3 months incur several warranty claims, do I expense it in the third month as well? Wouldnt that be double counting? Also what if my estimate was lower or higher than my actual warranty expense? How do I account for that?

I also want to ask, if I am studying from the curriculum, I am finding note taking hectic due to how long the curriculum is. Is it ideal to highlight the pdf version of the books on Bookshelf instead of the classic paper and pen note taking methodology?

  • The Pros: When you’ve finished studying, it is much easier to review with your notes then to go through the curriculum again
  • The Cons: You never finish on time if you write your own notes (it worked back in University with 5 courses, but not with CFA) at least for me. So I am a bit on edge and scared to alter my study method, but I am slowly realizing it is too slow.

Thanks.

#2

When you account for a warranty, the accounting entry is Dr expense / Cr warranty provision. At each closing (say once per month) you book such an entry to basically keep the provision at the level you estimate is correct. This is done, so that the expense refers to the correct period it was incurred (in cases of warranties, it is basically incurred continuously, as the phones are being sold, even if the actual claims are not claimed at that point). When an actual claim comes, you need to payout some cash back. The entry then would be Dr warranty provision / Cr cash. There is no double counting of the expense, as you only affect two balance sheet accounts.

If your estimate was wrong, what happens really depends on when you catch that fact. If it refers to another reporting period, you might need to make restatements to correct this cut-off error. If it’s within the same reporting period, just update the estimate on the next closing.

#3

Thank you!