4. Estimated Liabilities

This section accounts for estimated liabilities, including warranties and bonuses.

What is an estimated liability?

A known obligation of an uncertain amount that can be reasonably estimated.

What are common examples of estimated liabilities?

Employee benefits such as pensions, health care, vacation pay, and warranties offered by a seller.

What are some employee benefits provided by the company?

An employer often pays all or part of medical, dental, life, and disability insurance.

What else do employers contribute to?

Many employers also contribute to pension plans.

What are pension plans?

Agreements by employers to provide payments to employees after retirement.

What else do companies provide to their retirees?

Many companies also provide medical care and insurance benefits to their retirees.

What is the entry to record when an employee agrees to pay for the employee’s medical insurance and contribute a percentage of the employees’ gross salaries to a retirement program?

debit Employee Benefits Expense, credit Employee Medical Insurance Payable for amount company pays, credit Employee Retirement Program Payable for calculated amount (% of gross salary).

Review example under health and pension benefits.

When are vacation benefits estimated and expensed?

In the period when employees earn them.

What is the year-end adjusting entry to record accrued vacation benefit (the company records this)?

debit Vacation Benefits Expense, credit Vacation Benefits Payable

What is an accrued expense>

An unpaid expense and is also called an accrued liability.

What type of account is Vacation Benefits expense?

An operating expense

What type of account is Vacation Benefits Payable?

A current liability

What is the entry to record when the employee takes a vacation (company records this)?

debit Vacation Benefits Payable, credit Cash

What do many bonuses depend on?

Depends on the amount of net income.

What is the year-end adjusting entry to record a bonus?

debit Employee Bonus Expense, credit Bonus payable

What is a warranty?

A seller's obligation to replace or fix a product or service that fails to perform as expected within a specific period.

When does the seller report expected warranty expense?

The seller reports the expected warranty expense in the period when revenue from the sale of the product is service is reported.

What type of account is warranty to a seller?

A liability.

Review

The seller reports this warranty liability, even though the existence, amount, payee, and date of future payments are uncertain. This is because warranty costs are probable and the amount can be estimated using past experience.

What is the end-of-period adjustment to record the estimated expense and liability related to a sale?

debit Warranty Expense, credit Estimated Warranty Liability

When else can the entry to record the estimated expense and liability relate to a sale be recorded?

At the time of the sale.

Which financial statement is estimated warranty expense reported on?

Income statement

Which financial statement is warranty liability reported on?

The balance sheet.

What is the entry to record a repair if it fixes the item with parts?

debit Estimated Warranty Liability, credit Parts Inventory by same amount

When the customer brings an item in for warranty purposes, is the expense recorded at the time of repair?

No because the warranty expense was previously recorded in the year the item was sold with the warranty.

What happens if total warranty expenses are more or less than lets say an estimated 4%? (as an example)

Management should monitor actual warranty expenses to see if a 4% rate is accurate. If not, the rate is changed for future periods.

Can estimated liabilities be both long term and current term?

Yes.

Give an example of multi-period estimated liabilities.

Pension liabilities to employees are long term to workers who will not retire within the next year. For employees who are retired or will retire within the next year, a portion of pension liabilities is current.

Other examples include employee health benefits and warranties.

Review Need-To-Know 11-3