Measurement and Accounting for Warranty Obligations

✦ Warranty obligations arise when sellers provide guarantees against defects or issues with products sold.

✦ Under ASC 460, warranty obligations must be recognized as liabilities at the time of product sale if future warranty costs can be reasonably estimated.

✦ Warranty costs are recorded using estimated future costs based on historical data and expected product performance.

✦ Proper accounting ensures matching of warranty expense with related sales revenue and accurate liability estimation.

1. Types of Warranty Obligations

✦ Warranties typically fall into two categories:

• Assurance-type warranties – standard guarantees included in product sale price. 

• Service-type warranties – sold separately or offered as an optional purchase, creating separate performance obligations under ASC 606.

2. Initial Recognition and Measurement

✦ Recognize warranty liability at the time of sale for assurance-type warranties.

✦ Measurement based on estimated costs of warranty claims, typically using:

 • Historical warranty claim rates. • Product reliability data. • Industry benchmarks and expectations.

Entry at point of sale:

debit Warranty Expense – $10,000credit Warranty Liability – $10,000

3. Service-Type Warranty Accounting (ASC 606)

✦ Service-type warranties represent separate performance obligations.

✦ Allocate a portion of the transaction price separately and recognize revenue over the warranty period.

Example of initial entry:

debit Cash – $1,000credit Deferred Warranty Revenue – $1,000

Entry to recognize revenue monthly:

debit Deferred Warranty Revenue – $100credit Warranty Revenue – $100

4. Settlement of Warranty Claims

✦ When warranty services are provided or cash payments are made to customers:

Entry for warranty claims incurred:

debit Warranty Liability – $2,000credit Inventory / Cash / Parts – $2,000

5. Adjustment to Estimates

✦ Periodically reassess warranty obligations based on actual claim experience.

✦ Adjust liability and expense prospectively.

Entry for additional liability:

debit Warranty Expense – $1,500credit Warranty Liability – $1,500

6. Balance Sheet and Income Statement Impact

✦ Warranty liability is recorded as a current liability on the balance sheet.

✦ Warranty expense is presented within cost of sales or operating expenses, depending on nature and significance.

7. Disclosure Requirements

✦ Disclose in notes:

 • Nature and terms of warranties offered. • Methodology used to estimate warranty liabilities. • Reconciliation of warranty liability balances (beginning balance, accruals, payments, adjustments).

8. IFRS Comparison (IAS 37 / IFRS 15)

Topic	US GAAP (ASC 460 / ASC 606)	IFRS (IAS 37 / IFRS 15)
Assurance-type warranty	Accrued at sale	Same
Service-type warranty	Separate revenue obligation	Same
Liability estimation	Historical and expected costs	Same
Disclosure	Comprehensive disclosures	Same

9. Common Errors

✦ Failing to recognize warranty expense at the time of sale.

✦ Misclassifying service-type warranties as assurance warranties.

✦ Not regularly updating estimates based on actual claim data.

✦ Omitting necessary disclosures on warranty obligations and liabilities.

✦ Incorrectly accounting for warranty settlements (e.g., charging to expense rather than liability).