Many if not most consumer goods are sold subject to some kind of product warranty. This includes everything from microwaves and computers to automobiles and trucks. Sales of products subject to warranties present yet another challenge to accrual accounting. What is it all about warranty accounting? What is it all about warranty accounting? What is it all about warranty accounting?
Purchase a warranty
If a customer has the option to separately purchase a warranty, then an entity accounts for that warranty as a performance obligation. If a customer does not have the option to separately purchase a warranty, then the entity accounts for the warranty using the cost accrual guidance in IAS 37 ‘Provisions, Contingent Liabilities and Contingent Assets’ unless all or part of the warranty provides the customer with an additional service beyond the assurance that the product will comply with agreed-upon specifications.
IFRS 15 Revenue from Contract with Customers provides examples of factors that an entity must consider in determining whether a warranty provides a customer with an additional service. These are described in the following table: What is it all about warranty accounting?
Factors in setting warranties
Whether the warranty is required by law
A legal requirement to provide a warranty indicates that it is not a performance obligation because such laws are typically intended to protect the customer from the risk of purchasing a defective product
Term of the warranty coverage period
The longer the coverage period, the more likely a warranty is a performance obligation
Nature of the tasks the entity promises to perform under the warranty
|If an entity must perform certain tasks to provide assurance to the customer that the product complies with agreed-upon specifications, those services do not likely constitute a separate performance obligation.|
Separate performance obligation
If an entity determines that a warranty provides a service that is separate from assurance on the product’s compliance with agreed upon specifications, that service is considered to be a separate performance obligation. The entity allocates a portion of the transaction price to that service unless it cannot reasonably account for the assurance and service portions of the warranty separately. If an entity determines that it cannot reasonably separate the assurance and service components of a warranty, it accounts for both together as a single performance obligation. What is it all about warranty accounting?
In summary a decision tree: What is it all about warranty accounting?
Accounting for warranties
The fundamental idea of accrual accounting is that revenues are recognized when the earnings process is complete and not necessarily when the goods or services are paid for. In many cases determining when the earnings process is complete is very easy. A bar that lets patrons run a tab has a completed earnings process every time a customer is poured a drink. However in many businesses the completion of the earnings process is not so clear cut. Take the case of product sellers who offer warranties to purchasers.
Some kind of product warranty
Many if not most consumer goods are sold subject to some kind of product warranty. This includes everything from microwaves and computers to automobiles and trucks. Sales of products subject to warranties present yet another challenge to accrual accounting.
Bust Buy sells silicon gel implants used in cosmetic surgery. Each pair of implants sells for $1,000. However they offer a ten year warranty. If their implants fail they will replace them with new ones. When is the earnings process complete? It would seem that the “firm“is on the “hook” to “support” their product for ten years. So from one standpoint they should not recognize a completed sale until ten years have elapsed. What is it all about warranty accounting?
Product warranty expiration
But waiting until a product warranty expires seems like an extreme application of the accrual accounting concept. After all if manufacturers and producers thought that actual warranty costs were very significant they either would not sell the product at all, improve the product or go out of business. What is it all about warranty accounting?
A more realistic approach and the one sanctioned by IFRS is to allow warranty issuers to make reasonable estimates of the costs of meeting product warranties and recognize these warranty costs when sales are made. What is it all about warranty accounting?
See also: The IFRS Foundation