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 18.104.22.168
. 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?
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?
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.