 A product warranty is a promise made by a seller to a buyer to warrant a product against defect for some period of time. From an accounting perspective, a warranty is an example of a probable contingent liability. This means we will record a journal entry to record the warranty liability before the actual warranty claims happen. This is also an estimated liability because we don't know exactly how many units will require warranty work. We estimate the expense and liability and record it in the same period as the sale. This adheres to the matching principle which we learned about earlier. So let's look at an example. Arcade Fire sells 10,000 CDs at an average price of $10 each. The selling price includes one year warranty against disc defect. Arcade Fire expects that 500 units, or 5%, will be defective and that the warranty repair cost will average about $8 per unit. In 2015, the company honors warranty contracts on 300 units at a total cost of $2,400. So let's compute the warranty expense. Remember this is an estimated amount. We take 10,000 CDs times 5%, which is our estimated effective rate. This gives us an estimate that 500 CDs will need to be replaced due to defect. The cost to repair or replace is $8 per CD. So our estimated expense and liability is $4,000. The journal entry to record the expense is a debit to warranty expense and a credit to estimated warranty payable for $4,000 each. This journal entry would be made during the same period we recorded the sale of the 10,000 CDs. The journal entry to record the warranty claims is a debit to estimated warranty payable and a credit to inventory or cash for $2,400. Estimated warranty payable is debited because the liability is decreased once some of the claims are settled. Finally, at December 31st, what is the balance in the estimated warranty payable account? Well I like to use a T account to answer questions like this. In this case, the account was initially credited for $4,000 when the expense was recorded. We debited the account when we settled some of the warranty claims, leaving a credit balance of $1,600 at year end, which is the remaining estimate of our outstanding warranty.