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A warranty liability is a listing in financial accounts. It details the estimated amount the company will have to spend during a set period on meeting its obligations under product warranties, such as repairs and replacements. The term warranty liability can also cover the legal risks that a person involved in a negotiable instrument will automatically take on.
The main use of warranty liability is in a company's accounts, specifically its balance sheet. It is an attempt to take account of the fact that a company may incur future expenses related to goods it has already sold. These will occur if the goods suffer a fault while under the company's warranty.
The aim of the warranty liability is to forecast the actual figure the company will need to spend on warranty-related expenses. This takes into account several factors, most notably the number of goods under warranty, the average cost of a warranty expense, and the predicted chances of making a warranty payment on each item. The figure will need to be recalculated each year to account both for new sales and for the declining warranty period remaining on items sold in previous years.
When the warranty liability for a particular period is calculated, this amount is listed as both a liability on the balance sheet and an expense on the general accounts. As time goes on, any money actually spent on warranty payouts is deducted from the liability figure rather than listed as a new expense. The remaining figure then represents the amount that the manufacturer expects to pay out during the rest of the accounting period. The difference between the original estimated warranty liability and actual warranty expense over time is thus reflected in changes to the listed warranty liability on future balance sheets rather than as an expense.
US accountancy law requires companies to list warranty liabilities on balance sheets if two conditions are met. The first is that making a payout is probable: that is, it is likely. The second is that the cost of the payouts is capable of being calculated. In almost all circumstances, warranty liabilities will meet these two conditions.
The term warranty liability also has an unconnected meaning, describing a legal concept. This involves negotiable instruments, which are documents guaranteeing the payment of a set amount of money, the most notable examples being checks. Both the person issuing the negotiable instrument and the person presenting it for payment automatically take on certain legal liabilities, for example in the event of fraud. These liabilities, which exist without having to be specified in a contract, are known as warranty liabilities.
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