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How is warranty expense handled for book and tax purposes? Lets say you sell a car with a three year warranty in 1995. I would guess a liability is set up in 1995 to cover estimated cost and thereby match income with expenses. If in year three the expense is greater than the estimate what year does the additional expense get written off, 1995 or 1998? What happens in year four if the company decides to cover an expense. Does that expense get deducted in 1995 or 1999. What are the rules for book and tax and where can I find them?

As I understand it, companies record a reserve to cover warranty expenses based on their past experience and perhaps other factors. The actual expenses for warranty service are booked as expenses, and deducted from the reserve, in the year in which the service is performed. If the actual expense exceeds the reserve, the excess simply adds to the then-current year's warranty expenses.

As for financial accounting vs. tax accounting, I believe that the Generally Accepted Accounting Principles (GAAP) govern the former while the Internal Revenue Code together with case law and private letter rulings govern the latter.

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