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Estimated Liabilities: Definition & Types

Estimated Liabilities: Definition & Types
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  • 0:01 What Are Estimated Liabilities
  • 1:09 Retirement As An…
  • 2:22 Warranties As An…
  • 3:17 Property Tax As An…
  • 4:07 Lesson Summary
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Lesson Transcript
Instructor: Tammy Galloway

Tammy teaches business courses at the post-secondary and secondary level and has a master's of business administration in finance.

In this lesson, you'll learn about estimated liabilities. We'll discuss three types of estimated liabilities: retirement, warranties and property taxes. We'll also explore suggestions on how to estimate the amount owed.

What Are Estimated Liabilities?

Jan just graduated from college and landed her dream job as a junior accountant at ABC Technology Corporation. Her first project is to create financial statements. She starts with the balance sheet and completes each line item accurately except for retirement, warranties, and property taxes. She leaves those blank because she's unsure of the dollar amounts.

When she meets with her boss, she shows how she completed the balance sheet except for three line items. Her boss asks, 'Why did you leave these three lines blank?' Jan replies, 'Because we do not know the exact dollar amounts.'

Her boss says adamantly, 'Liabilities are obligations that we owe. We must include all the liabilities to show an accurate balance sheet. Retirement, warranties and property taxes are what we call estimated liabilities, and even though we don't know their actual totals, we must provide our best guess.'

For the remainder of this lesson, we'll explain the most widely known estimated liabilities: retirement, warranties and property taxes. You'll also learn how to estimate these types of liabilities.

Retirement as an Estimated Liability

Liabilities are obligations that are owed, and while most liability amounts are known, there are some Jan will need to estimate to complete the balance sheet.

ABC Technology Firm has been in business over 50 years. The company has hundreds of employees who have retired with a pension. A pension is a retirement plan where the employee, during their working career, has a percentage of their paycheck deducted for retirement. Once they retire, they receive a monthly check for life. These monthly payments must be included on the balance sheet as a liability.

The current retiree payments are easy to calculate as liabilities because they're already being paid and we know the exact dollar amount. However, there may be employees retiring this month, which will need to be estimated to accurately calculate retirement liabilities.

Jan decides to go to ABC's human resource department to determine who's eligible to retire this month. Based on the number of people eligible and their pension benefits, she will add this number to retirement liabilities to reflect the most current, available information. At best, her calculations may be overestimated since some employees who are eligible to retire may not. Now she needs to tackle warranties.

Warranties as an Estimated Liability

ABC Technology is a well-respected company. They claim to have the best employees, manufacturing plants and most innovative, reliable products. Their motto is, 'If it breaks, we'll replace!' They are so confident in their products that they offer a 5-year warranty. A warranty is a promise to repair or replace a damaged part or product.

To estimate warranties, Jan pulls last year's financial statements and finds sales and warranties. She finds sales of $1,000,000 and warranties of $100,000. Jan takes $100,000 of warranties and divides it by $1,000,000 in sales to derive at 10%. Therefore, warranties are typically 10% of sales.

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