Collateral liability is a financial listing of estimated expenses a company will incur to meet product warranty obligations. It appears on balance sheets and accounts and is recalculated annually. It also refers to legal responsibilities assumed by parties involved in negotiable instruments.
A collateral liability is a listing on financial accounts. It details the estimated amount the company will have to spend over a set period to meet its obligations under product warranties, such as repairs and replacements. The term collateral liability can also cover legal risks that a person involved in a negotiable instrument will automatically assume.
The primary use of collateral liability is on a company’s accounts, specifically its balance sheet. It is an attempt to take into account the fact that a company may incur future expenses related to goods it has already sold. This will occur if the products fail while under the company’s warranty.
The goal of warranty liability is to forecast the actual amount the company will need to spend on warranty-related expenses. This takes into account several factors, especially the number of products under warranty, the average cost of a warranty expense, and the anticipated chances of making a warranty payment on each item. The figure will need to be recalculated each year to take into account both new sales and the decreasing warranty period remaining on items sold in prior years.
When the warranty liability is calculated for a particular period, this amount appears as a liability on the balance sheet and an expense on the general accounts. As time passes, any money actually spent on warranty payments is deducted from the liability figure instead of being listed as a new expense. The remaining figure represents the amount the manufacturer expects to pay during the remainder of the accounting period. The difference between the original estimated warranty liability and the actual warranty expense over time is reflected in changes to the warranty liability shown on future balance sheets rather than as an expense.
United States accounting law requires companies to list collateral obligations on balance sheets if two conditions are met. The first is that making a payment is probable: that is, it is probable. The second is that the cost of payments can be calculated. In almost all circumstances, warranty obligations will meet these two conditions.
The term warranty liability also has an unrelated meaning, describing a legal concept. This involves negotiable instruments, which are documents that guarantee the payment of a fixed amount of money, the most notable examples being checks. Both the person who issues the negotiable instrument and the person who presents it for payment automatically assume certain legal responsibilities, for example, in case of fraud. These responsibilities, which exist without having to be specified in a contract, are known as warranty obligations.
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