Practical Application in Accounting: Calculating Warranty & Service Costs

Instructor: Scott Tuning

Scott has been a faculty member in higher education for over 10 years. He holds an MBA in Management, an MA in counseling, and an M.Div. in Academic Biblical Studies.

Costs associated with warranty service are handled a little differently in terms of accounting. In this scenario, you'll have a chance to analyze a fictional company's data. Then you'll be asked to accurately project warranty and service costs.

Standing Behind Your Products

Have you ever purchased an item, perhaps a piece of furniture, and while unpacking saw something like the tag below?

Stop Sign

Why does a manufacturer really want you to deal directly with them instead of just having you return an item to the store? Although there are a couple of benefits to doing it this way, one of the biggest benefits is that it helps them control the costs associated with defective products. US consumer protection laws give purchasers robust rights with regard to warranty and service. One such protection we're probably all familiar with is the so-called ''lemon law'' which provides some consumers (particularly related to auto sales) the right to demand an entirely new product if the manufacturer cannot fix the problem.

No matter how good a manufacturing system might be, a certain percentage of their shipped products will have defects or deficiencies. Businesses can curb these costs at both ends. On the front end, a business can take steps to decrease the number of defective units. On the back end, the manufacturer can work with customers to provide the service they need in the most efficient way possible. Let's look at a scenario in which a business needs to calculate its warranty and service costs as part of its annual budget process. You'll be asked to read a scenario containing references to the lesson entitled Recording Warranty and Service Costs. Then you'll be asked to perform some of the functions on your own before checking your answers.

SupremeGreen Sprinkler Supply

SupremeGreen Sprinkler Supply is a retail business that sells sprinkler and landscaping supplies to contractors as well as the general public. Like many retailers, SupremeGreen carries its own line of products, but it also sells other brands as well. Like any business that sells products, SupremeGreen has customer returns. In an increasingly competitive market, SupremeGreen wants to streamline operations, and minimizing expenses associated with returns are one of the things that the company is focusing on. Put yourself in the role of a consultant that has been contracted to help SupremeGreen tackle this issue.

What information do you need to get started with your analysis?

First Things First: Historical Trends

Unless there have been dramatic changes in operating methods, sales, or other core business functions, a great place to start is by looking into the past. When operations have been largely consistent, the past is one of the best predictors of the future. Here's what the trend for SupremeGreen looks like for the last 12 months:

Warranty Service Log

  • What does this data tell you?
  • Do you have enough information to calculate warranty and service costs? If not, what's missing?

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