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Question 17: How should an entity evaluate whether a product warranty is a performance obligation in a contract with a customer when the warranty is not separately priced?
Publication date: 31 Jan 2020
us FASB Staff Q&A Revenue 17
Reference(s): Section 606-10-25 and Paragraph 606-10-55-33
Topic 606 requires a warranty that provides a service in addition to the assurance that the product complies with agreed-upon specifications to be accounted for as a separate performance obligation. However, it does not include a bright line on how to make the distinction of when a warranty provides a service if the customer has the option to purchase a warranty, such as when it is separately priced or negotiated. Instead, Topic 606 provides three factors in paragraph 606-10-55-33 to consider in assessing whether a warranty provides a service. Because the assessment is based on an evaluation of factors, rather than determinative criteria, judgment based on the facts and circumstances will be necessary.
The staff concluded that, under Topic 606:
(a) An entity would account for a warranty as a performance obligation if it has an option to purchase the warranty, such as when it is separately priced or negotiated.
(b) Warranties also would be accounted for as performance obligations if the warranty provides the customer with a service in addition to the assurance that the product complies with agreed upon specifications. Therefore, the accounting for warranties under Topic 606 is different from existing GAAP. Entities might account for some warranties as performance obligations under Topic 606 that are not separate deliverables (or elements) under existing revenue guidance.
The evaluation of whether a warranty provides a service in addition to the assurance that the product complies with agreed-upon specifications will require judgment.
Consider the following example:
A luggage company provides a lifetime warranty that states: If your baggage is broken or damaged, we will repair it free of charge.
Paragraph 606-10-55-33 provides factors for evaluating whether a warranty provides a customer with a service in addition to the assurance that the product complies with agreed-upon specifications, using judgment of facts and circumstances. The following is a summary of those factors and analysis of each factor in the example above:
(a) If the warranty is required by law—The indicator states that if the entity is required by law to provide a warranty, the existence of that law indicates that the promised warranty is not a performance obligation. In this example, because there is no law that requires the entity to make a promise for the lifetime of the product, this indicator suggests the warranty is a performance obligation.
(b) The length of the warranty coverage—The indicator states that a longer warranty coverage period increases the likelihood that the warranty is a performance obligation. Because the length of the warranty is for the life of the baggage, this indicator suggests the warranty is a performance obligation.
(c) The nature of the tasks that the entity promises to perform—In the above example, the nature of the tasks not only includes repairing baggage that does not meet the promised specifications, but also includes replacing broken or damaged baggage for free. Because the baggage warranty goes beyond the promise that the baggage complies with agreed-upon specifications, this indicator suggests the warranty is a performance obligation.
For the example above, on the basis of the promise provided and an analysis of the factors included in paragraph 606-10-55-33, the staff thinks the warranty provided by the baggage company is a service in addition to the assurance that the product complies with agreed-upon specifications. Consequently, the staff thinks the service should be accounted for as a performance obligation.
The staff thinks that the guidance in paragraphs 606-10-55-33(a) and 606-10-55-35 should not be applied by analogy for warranties that are not required by law and that such an analogy disregards the nature of the promise given to the customer, the factors in paragraph 606-10-55-33 for determining whether a warranty is a performance obligation, and the overall facts and circumstances of the arrangement.
The staff thinks that while the length of the warranty alone is not determinative, the length of the warranty is an important consideration under Topic 606. The indicator included in paragraph 606-10-55-33(b) states that the longer the warranty coverage, the more likely the warranty is a performance obligation.
Overall, an entity should not focus its assessment on when the fault in the product arises. Rather, entities should evaluate if the substance of the warranty reflects an additional service, considering the promise made, and using the factors in paragraph 606-10-55-33 for assessing if warranties are performance obligations in Topic 606.
In conclusion, the evaluation of whether a warranty provides a service in addition to the assurance that the product complies with agreed-upon specifications will require judgment of facts and circumstances. While the example above illustrates a relatively straight forward set of facts and circumstances that demonstrate an instance of when a warranty provides a service, the staff would expect that there are other instances for which more judgment will be required. In those cases, the staff thinks an entity should consider all relevant facts and circumstances in applying the guidance in Topic 606, including the factors in paragraph 606-10-55-33.
Copyright #year# by Financial Accounting Foundation, Norwalk, Connecticut.
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