Warranty expense is an example of a situation when taxes payable are greater than income tax expense because on the income statement statment estimated warranty expense is deductible and on the tax return only actual warranty expenses are deductible. I’m trying to understand that through an example. Dell sells a $1,000 laptop with estimated cost of warranty over 3 year period of $300. Can someone explain how warranty is treated on the balance sheet? is it going to be recognized as a liability and an asset and then gets depreciated and the depreciation causes the warranty expense?
Don’t know if this is correct, but I feel this is what could have happened. When Dell sold that $1000 laptop along with the Warranty of $300 for 3 years they would account for that extra $300 (Warranty Cost) as incurred and would deduct it from the Income as an Expense item. Now they have less taxable income and low tax payable. Suppose, 1 year later, the customer comes back with a broken key and it’s under warranty, so Dell has to replace the keypad which cost them around $136. So this was the real cash outflow, but they accounted for complete $300 initially… This difference has caused a differed tax Liability… Lemme know your views? - Dinesh S
My understanding is that there is no DTL, warranty expense causes a DTA when a laptop is sold and then actual warranty expenses cause DTA reduction.
If you assume the warranty repair won’t happen in the first year, then it is a DTA. For tax purposes the warranty repair costs aren’t deducted from income until the repairs are actually done (cash basis) For accounting, the warranty expense could be 100 a year stretched over 3 years. So, assume the total costs of the sale are 600. Accounting pretax income is 1000-100-600=300 Taxable income (tax reporting) assuming no repair until a later year is 1000-600=400. You end up paying more tax then is recorded on the financial statements, which is a tax asset (deferred to a later period). When the warranty costs are actually incurred then they are deducted from taxable income and the DTA reverses.
Dimes27, are you saying warranty is an off-balance sheet liability?
No it should on the balance sheet. Their will be a warranty liability of 300 (or it will be 100 the first year, then added to after that). When the warranty repairs are actually done, then the costs will be offset against the liability which brings the liability back to 0 over time. My accounting knowledge is pretty basic so maybe someone else wants to ring in, but I know the warranty estimation is carried as a liability until it is actually needed. Kind of like the situation of keeping a reserve against A/R for bad debt expense.
This is what I think happens When you sell a laptop for 1000 dollars, based on statistics you can estimate that over 3 years will have a warranty expense of 300 dollars.In order to be accurate and prudent you have to reflect that into accounting. So you record expense 300= allowance account 300(valuation allowance) when the actual things are paid let say 100 dollars in first year allowance account 100 = cash 100 (or labor , parts etc) basically both accounts decrease their balances Now if the expense is less that what was expected the part of expense not incurred is transfered back to revenue allowance 100= revenue 100 What do you guys think?
You have to differentiate between the situation where the warranty is included for free (like a car with a 5 year warrant for various items), and situations where you buy an extended warranty beyond the invluded coverage (ie a 90 day coverage on a laptop is extended with a 3 year service contract). The first situation is what is really being addresed, and florinpop does a good job of explaining it. For GAAP purposes you record the initial liability and expense, and reduce the liability as expenses are incurred (as said above). For tax purposes you record the expense on a cash basis. This is what gives rise to the deferred tax asset up front.