Revenue recognition in case of warranty contracts
It is common for an entity to provide warranty in connection with the sale of a product.
- either as per the contract or
- as per the law or
- as per entity’s customary business practice
But, the nature of a warranty provided can differ depending on the contract type and industry.
- While some warranty contracts provide basic assurance that product will function as the parties intended (because it complies with agreed-upon specifications)
- some provide the customer with a service, in addition to the assurance.
Obligations decide if its additional service or basic assurance:
Following factors must be considered in determining whether a warranty provides customer with additional service, in addition to the basic assurance
a) Whether the warranty is required by law—
A legal requirement to provide warranty, indicates that the promised warranty is not a performance obligation since these legal requirements are typically intended to protect customers from the risk of purchasing defective products.
b) length of the warranty coverage period—longer the coverage period, more likely it is a performance obligation.
c) The nature of the tasks that the entity promises to perform—
If an entity is required to perform specified tasks in order to provide the assurance: (for example, a return shipping service for a defective product), then promised warranty does not give rise to a separate performance obligation.
*Assurance: assurance that the product complies with agreed-upon specifications.
Treatment:
a) If a customer has the option to purchase a warranty separately (where warranty is priced or negotiated seperately) -----> warranty in that case, is a distinct service and should be accounted as a performance obligation separate from the product. Allocate the portion of transaction price to that performance obligation.
b) If a customer does not have the option to purchase a warranty separately, an entity shall account for the warranty in accordance with Ind AS 37, Provisions, Contingent Liabilities and Contingent Assets.
exception to (b): When the promised warranty, provides the customer with a service in addition to the basic assurance ---> In which case, the promised service is a performance obligation and entity shall allocate the transaction price to the product and the service.
If an entity promises both an assurance-type warranty and a service-type warranty but cannot reasonably account for them separately, the entity shall account for both of the warranties together as a single performance obligation.
c) A law that requires an entity to pay compensation if its products cause harm or damage does not give rise to a performance obligation.
Similarly, entity’s promise to indemnify the customer for liabilities and damages arising from claims of infringement by the entity’s products, it does not give rise to a performance obligation and entity shall account for such obligations in accordance with Ind AS 37