Warranties are a common aspect of many businesses. The new revenue standard updates the model for assessing these items, and could result in a change to your accounting. PwC’s Michelle Dion shares her perspectives on key areas to think about, including assessing service elements, the impact of cash payments, and more.
Hi, I’m Michelle Dion, a senior manager in PwC’s National office.
In this video I want to share some information on how the accounting for warranties may be impacted by the new revenue standard.
Companies may provide customers with a warranty in connection with the sale of a good or service. The nature of a warranty can vary. They may be called a standard warranty, a manufacturer's warranty, or an extended warranty. Regardless of the name, these generally provide assurance that the product or service will function as expected.
Warranties that can’t be purchased separately must be assessed to determine whether the warranty provides a service that should be accounted for as a separate performance obligation.
Warranties against product defects are not separate performance obligations. These types of warranties will continue to be accounted for as a cost accrual under the new revenue standard.
However, sometimes warranties includes a service element that provides 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. The additional service provided in a warranty should be accounted for as a separate performance obligation, assuming the service is distinct from the other goods and services in the contract. This will require some warranties to be separated between an assurance element and a service element.
Today, there is diversity in practice with respect to accounting of warranty obligations that include a service element. While some companies separate the service element from the assurance-type warranty, others account for the entire obligation as a cost accrual.
Under the new revenue standard, companies that cannot reasonably account for the service element of a warranty separate from the assurance element should account for both as a single performance obligation that provides a service to the customer.
Some arrangements also provide for cash payments to the customer, for example, liquidated damages for failing to comply with the terms of the contract. These arrangements should generally be accounted for as variable consideration, as opposed to a warranty expense. However, cash payments to customers might be accounted for as warranties in limited situations, such as a direct reimbursement for costs paid by the customer to a third party for repair of a product.
Finally, a warranty that a customer can purchase separately from the related good or service, that is, it is priced and/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. Revenue allocated to the warranty would typically be recognized ratably over the warranty period.
Those are the key considerations to think about. For more information on this and other revenue topics, please refer to our Revenue guide available on CFOdirect.com.