When water leaks onto drywall it can cause minor damage like staining to the paint finish; very severe damage like bulging in the wallboard; or some degree of damage in between, like bubbling joint compound and peeling tape.
Repair bubbling joint compound and paint using a putty knife to scrape off all the damaged material. Cut and remove any peeling drywall tape. Brush away the scraping dust and prime all the visible damage with primer-sealer to block the stain and seal the damaged surface. Let the primer dry and replace any missing tape using fiberglass mesh. Use the techniques for drywall and plaster crack repair to cover the tape.
When exposed to a lot of water, drywall tends to warp as the gypsum swells. When it dries, the gypsum may harden into a bulging wall or ceiling surface. This bulging gypsum will tend to be harder than before it got wet. This will be true of plaster with gypsum board lath also. Bulging gypsum like this will always need to be cut out and replaced to restore a flat surface.
To replace water-damaged drywall, mark a square around the bulging area. Try to remove the drywall along the original seams if possible. This will give you framing to attach the replacement piece and make it easier to cut the hole square.
Score repeatedly with a sharp blade until you cut through the gypsum and paper. Remove any screws or nails holding the drywall up and pull the damaged wallboard free.
Cut a new piece of drywall of the same thickness and fit it into the space. With drywall, match finished edges and open edges to avoid a ridge in the finished repair.
With gypsum board plaster, use a new piece of drywall that will be a little below the surrounding wall or ceiling surface. Build up over the patch piece with joint compound, to restore a smooth surface.
Using a setting compound for this repair will minimize problems like bubbles in the new paint, from residual moisture. Ready-mixed can also be used to finish the seams if you cut far enough back that the perimeter is completely dry.
Tape the joints around the new piece of drywall with mesh tape and apply a first coat of mud using the techniques for finishing drywall seams or repairing wall cracks with mesh tape. If the new patch is level with the surrounding surface, finish the seams as described in finishing drywall seams, prime and touch up the paint.
If the patch is below the surface of the surrounding drywall, let the tape follow the contour of the seam to stick flat to each surface. Then apply a thick coat of mud to the seams and surrounding drywall. Immediately skim the excess mud working from the center of the tape out, on both surfaces. Use light pressure to avoid pulling the tape off but press hard enough to leave only a thin coat of mud covering the mesh and both surfaces. The uneven joint will be leveled out in the next step.
When the seams dries, apply a coat of mud to level out the patch. On large areas, use a slow acting setting compound like Durabond90® to give yourself time to work.
Use a broad joint knife to apply a thick coat of mud that fills in over the patch and overlaps the taped edges.
Immediately skim the excess mud from the patch to level it with the surrounding drywall. Use a straight edge like a 1x3, long enough to span the whole repair, to skim off the excess mud. Rest the board on the surrounding drywall and draw it across the patch, stopping to remove the collected mud as you go.
Work across the patch to leave the mud flush with, or just below the surrounding surface. Around the perimeter of the patch, skim the mud as thin as possible with the joint knife to help blend it into the surrounding surface. Go over the wet mud again with the straight edge if needed to smooth out any marks from the board. Ignore any minor voids in the plaster coat, they will be filled in the next application.
Let the mud set for about an hour and scrape off any protrusions using the joint knife. Don't try to completely smooth out the surface here, just knock off any peaks or ridges in the mud. When the edges of the repair turn white, lightly sand there. Brush off the dust and wipe the surface with a damp rag to remove any joint compound residue.
Apply a thick coat of mud over the patch, overlapping the edges of the floated coat. Skim the excess mud off using the joint knife held at about 30°. Make parallel strokes across the patch in the same direction as the float coat, using firm pressure with the knife. Ignore any ridges left by the edge of the blade, you will scrape them off when the mud sets.
Let the first coat set and then skim coat the area as many more times as needed to build a smooth surface over the patch.
Skim each coat in the opposite direction of the one before. If you skimmed the first coat with vertical strokes, apply the next with horizontal strokes. Reverse skimming like this with each subsequent application will help eliminate any ripples or uneven surface.
Always overlap the edges of the previous coat of mud and skim the mud out as thin as possible around the perimeter to make final sanding easier. If necessary, sand the dry mud at the edges between coats to avoid a build up. Allow the final coat of mud to set and dry for an hour or more before final sanding.
Sand the dry joint compound lightly with 120 sandpaper. Tear a 8x11 inch sheet in half to form two 8x5½ inch pieces. Fold one of the pieces in half and hold it with the fold away from you. Fan out your fingers to apply even pressure and use a light touch. Start on one side of a repair and sand in wide arching strokes to gradually smooth out imperfections.
Be careful sanding around the edges of patches on drywall. The sandpaper can dig into the surrounding surface while you're trying to smooth out rough edges. Lightly sand across the edges to feather a smooth transition between the two surfaces.
Brush all dust from the surface and wipe with a damp rag before priming and painting. If you are using flat latex finish paint, you can use it to prime the repair. If you are using semi-gloss or other shiny paint, prime with flat latex or a latex primer first.