Warranties are commonly included in arrangements to sell goods or services. They may be explicitly included in the contractual arrangement with a customer or may be required by law or regulation. In addition, an entity may have established an implicit policy of providing warranty services to maintain a desired level of satisfaction among its customers. Whether explicit or implicit, warranty obligations extend an entity’s obligations beyond the transfer of control of the good or service to the customer, requiring it to stand ready to perform under the warranty over the life of the warranty obligation. Warranties in arrangements to sell goods or services Warranties in arrangements to sell goods or services
The price of a warranty may be included in the overall purchase price or listed separately as an optional product. While the standard notes that the nature of a warranty can vary significantly across industries and contracts, it identifies two types of warranties: Warranties in arrangements to sell goods or services
- Warranties that promise the customer that the delivered product is as specified in the contract (called ‘assurance-type warranties’)
- Warranties that provide a service to the customer in addition to assurance that the delivered product is as specified in the contract (called ‘service-type warranties’)
Assurance-type or Service-type warranties Warranties in arrangements to sell goods or services
If the customer has the option to purchase the warranty separately or if the warranty provides a service to the customer, beyond fixing defects that existed at the time of sale, IFRS 15 B29 states that the entity is providing a service type warranty. Otherwise, it is an assurance-type warranty, which provides the customer with assurance that the product complies with agreed-upon specifications. In some cases, it may be difficult to determine whether a warranty provides a customer with a service in addition to the assurance that the delivered product is as specified in the contract. To help entities make that assessment, the standard provides the application guidance in IFRS 15 B31 and IFRS 15 B33.
The following decision tree illustrates these requirements: Warranties in arrangements to sell goods or services
Document your decisions in your financial close file to facilitate internal review and approval and external audits.
Entities may need to exercise significant judgement when determining whether a warranty is an assurance-type or service-type warranty. An entity’s evaluation may be affected by several factors including common warranty practices within its industry and the entity’s business practices related to warranties. For example, consider an automotive manufacturer that provides a five-year warranty on a luxury vehicle and a three-year warranty on a standard vehicle. The manufacturer may conclude that the longer warranty period is not an additional service because it believes the materials used to construct the luxury vehicle are of a higher quality and that latent defects would take longer to appear. In contrast, the manufacturer may also consider the length of the warranty period and the nature of the services provided under the warranty and conclude that the five-year warranty period, or some portion of it, is an additional service that needs to be accounted for as a service-type warranty. IFRS 15 excludes assurance-type warranties, which are accounted for in accordance with IAS 37.
The standard provides the following example of a contract that includes two performance obligations, including a licence that provides a right to use the entity’s intellectual property and consideration in the form of sales-based royalties. In example 60 IFRS 15 IE307 – IE308, the licence is determined to be the predominant item to which the royalty relates.