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Reporting entities often provide customers with a warranty in connection with the sale of a good or service. The nature of a warranty can vary across reporting entities, industries, products, or contracts. It could be called a standard warranty, a manufacturer's warranty, or an extended warranty. Warranties might be written in the contract, or they might be implicit as a result of either customary business practices or legal requirements.
Terms that provide for cash payments to the customer (for example, liquidated damages for failing to comply with the terms of the contract) should generally be accounted for as variable consideration, as opposed to a warranty or a guarantee. Refer to RR 4.3 for further discussion of variable consideration. Cash payments to customers might be accounted for as warranties in limited situations, such as a direct reimbursement to a customer for costs paid by the customer to a third party for repair of a product.
Figure RR 8-1 summarizes the considerations when determining the accounting for warranty obligations.
Figure RR 8-1
Accounting for warranty obligations

8.3.1 Warranties that can be purchased separately

A warranty that a customer can purchase separately from the related good or service (that is, it is priced or negotiated separately) is a separate performance obligation. The fact that it is sold separately indicates that a service is being provided beyond ensuring that the product will function as intended. For example, an extended warranty is often sold separately and is therefore a separate performance obligation. Revenue allocated to a warranty that a customer can purchase separately is recognized over the warranty period.

8.3.2 Assurance-type warranties

A warranty that cannot be purchased separately and only provides assurance that a product will function as expected and in accordance with certain specifications is not a separate performance obligation. The warranty is intended to safeguard the customer against existing defects and does not provide any incremental service to the customer. Costs incurred to either repair or replace the product are additional costs of providing the initial good or service.
An assurance-type warranty is accounted for as a contingency pursuant to ASC 460-10-25-5, which requires recording a loss when the conditions in ASC 450-20-25-2 are met. That is, the loss is recorded when it is probable and can be reasonably estimated. Accordingly, the estimated costs are generally recorded as a liability when the reporting entity transfers the good or service to the customer. The cost is either the cost of repairing or replacing a defective good or reperforming a service. Although a warranty is a type of guarantee, assurance-type warranties (referred to as “product warranties” in ASC 460) are not subject to the general recognition provisions of ASC 460, which requires recognizing guarantees at fair value.
If a revenue contract includes guarantees in the scope of ASC 460 that are not warranties, the guarantee should be accounted for separate from ASC 606 revenue, as discussed in RR 2.2.3 and RR 4.3.3.9. For example, a reporting entity that is an agent may provide guarantees related to the goods or services provided by another party. These guarantees likely do not meet the definition of a warranty and should be accounted for under ASC 460, separate from the revenue contract. In some fact patterns, assessing whether a contract includes a warranty accounted for as a contingency or a guarantee subject to the recognition provisions of ASC 460 may require judgment.
Question RR 8-2 addresses the period over which to accrue estimated warranty costs when control of equipment transfers over time.
Question RR 8-2
Manufacturer constructs customized equipment for which control transfers to the customer over time. Manufacturer provides a one-year warranty on the equipment, which begins once the equipment is delivered to the customer. Should Manufacturer accrue the estimated warranty costs over the construction period or at the point in time it delivers the equipment to the customer?
PwC response
Manufacturer should generally accrue the estimated warranty costs over the construction period, consistent with the transfer of control of the equipment to the customer.

Question RR 8-3 addresses the accounting for the right to return a defective product.
Question RR 8-3
Is the right to return a defective product in exchange for cash or credit accounted for as an assurance-type warranty or a right of return?
PwC response
A return in exchange for cash or credit should generally be accounted for as a right of return (refer to RR 8.2). If customers have the option to return a defective good for cash, credit, or a replacement product, management should estimate the expected returns in exchange for cash or credit as part of its accounting for estimated returns. Returns in exchange for a replacement product should be accounted for under the warranty guidance.

8.3.3 Warranties that provide a service

Other warranties provide a customer with a service in addition to the assurance that the product will function as expected. The service provides a level of protection beyond defects that existed at the time of sale, such as protecting against wear and tear for a period of time after sale or against certain types of damage. Judgment will often be required to determine whether a warranty provides assurance or an additional service. The additional service provided in a warranty is accounted for as a promised service in the contract and therefore a separate performance obligation, assuming the service is distinct from other goods and services in the contract. A reporting entity that cannot reasonably account for a service element of a warranty separate from the assurance element should account for both together as a single performance obligation that provides a service to the customer. Refer to Revenue TRG Memo No. 29 and the related meeting minutes in Revenue TRG Memo No. 34 for further discussion of this topic.
A number of factors need to be considered when assessing whether a warranty that cannot be purchased separately provides a service that should be accounted for as a separate performance obligation.

ASC 606-10-55-33

In assessing whether a warranty provides a customer with a service in addition to the assurance that the product complies with agreed-upon specifications, an entity should consider factors such as:

  1. Whether the warranty is required by law—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 because such requirements typically exist to protect customers from the risk of purchasing defective products.
  2. The length of the warranty coverage period—The longer the coverage period, the more likely it is that the promised warranty is a performance obligation because it is more likely to provide a service in addition to the assurance that the product complies with agreed-upon specifications.
  3. The nature of the tasks that the entity promises to perform—If it is necessary for an entity to perform specified tasks to provide the assurance that a product complies with agreed-upon specifications (for example, a return shipping service for a defective product), then those tasks likely do not give rise to a performance obligation.

Question RR 8-4 addresses the accounting for repairs provided outside of the contractual warranty period.
Question RR 8-4
Should repairs provided outside of the contractual warranty period be accounted for as a separate performance obligation?
PwC response
It depends. Management should assess the nature of the services provided to determine whether they are a separate performance obligation, or if there is simply an implied assurance-type warranty that extends beyond the contractual warranty period. This assessment should consider the factors noted in ASC 606-10-55-33.

Example RR 8-3 illustrates the assessment of whether a warranty provides assurance or additional services. This concept is also illustrated in Example 44 of the revenue standard (ASC 606-10-55-309 through ASC 606-10-55-315).
EXAMPLE RR 8-3
Warranty – assessing whether a warranty is a performance obligation
Telecom enters into a contract with Customer to sell a smart phone and provide a one-year warranty against both manufacturing defects and customer-inflicted damages (for example, dropping the phone into water). The warranty cannot be purchased separately.
How should Telecom account for the warranty?
Analysis
This arrangement includes the following goods or services: (1) the smart phone; (2) product warranty; and (3) repair and replacement service.
Telecom would account for the product warranty (against manufacturing defect) in accordance with other guidance on product warranties, and record an expense and liability for expected repair or replacement costs related to this obligation. Telecom would account for the repair and replacement service (that is, protection against customer-inflicted damages) as a separate performance obligation, with revenue recognized as that obligation is satisfied.
If Telecom cannot reasonably separate the product warranty and repair and replacement service, it should account for the two warranties together as a single performance obligation.
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