A type of reserve that represents amounts of money set aside to be used for payment of warranty claims made by an entity’s customers against its products or services. The money set aside is meant to account for contingent liability. Warranty reserves, by nature, appear on the balance sheet. Therefore, a company increase the balance of warranty reserves in response to increase in sales. If no additional sales are reported, the balance of warranty reserves remain unchanged.

A warranty reserve is all amounts appropriated by a company to cover the cost of future warranty claims associated with its products/ services already delivered to its customers.

The reserve is often maintained at a certain level proportionate to annual warranty expense- the actual payment made for warranties during a year. For example, a warranty reserve might be equal to one quarter of a company’s annual warranty expense as set forth on its general ledger. Warranty expense is an expense arising from the repair, replacement, or compensation to a user for any defective products or services.

This reserve reflects management’s estimate of future costs that would be incurred for repairing or replacing defective products or fixing certain issues with below-expectation services provided.

Accounting for warranty reserves involves the process of accruing an expense, which reflects an estimate based on a series of historical data and management’s judgement. The warranty reserve balance is the balance left after deductions of warranty expenses for a given year. The warranty reserve is created as an accrued expense, corresponding to the estimated costs of warranty services during the warranty period.

The warranty expense arises when a product is sold, or revenue is recognized for completing all sales contract obligations to a customer. Companies are required to maintain a warranty reserve as a current liability and charge actual warranty expenses to this accumulated reserve at the time such expenses are incurred. Upon recognizing a revenue, a percentage of this revenue must be debited to the warranty expense account while the reserve account is credited.