Revenue recognition – Product warranties
Considering whether an entity should allocate revenue to all product warranties and, if not, to which warranties an entity should allocate revenue
As part of the IASB and FASB's continued redeliberations on the feedback received on their revenue recognition proposals, the Boards discussed accounting for product warranties. In the Exposure Draft, Revenue from Contracts with Customers, the Boards proposed that entities would assess whether the objective of a warranty was to provide coverage for either quality assurance or an insurance warranty. The quality assurance warranty protects against defaults which existed as part of production and would not give rise to a separate performance obligation but instead would represent a lack of fulfilment of the original performance obligation. An insurance warranty protects against future events and therefore would give rise to a separate performance obligation.
Almost all comment letter respondents stated that in practice it may be difficult to determine when a fault in a product has arisen (i.e., whether it relates to original production or future use). Additionally, some felt that because revenue would be deferred in any case under the proposals distinguishing between the two would not be cost beneficial. Some also commented that revenue deferral does not represent the underlying economics for some warranty arrangements, in particular standard warranties, which those respondents felt cost recognition was more appropriate than revenue deferral.
The Boards discussed the feedback received and acknowledged the concerns expressed over the operational complexity. The Boards tentatively agreed that some warranty arrangements should be a separate warranty obligation rather than a performance obligation. As a separate warranty obligation, there would be no revenue deferred and instead a warranty obligation and warranty expense would be recognised upon transfer. The Boards also discussed which warranty arrangements should meet this criteria as a separate warranty obligation (and conversely which would be considered a separate performance obligation and result in revenue deferral).
The IASB and FASB staff had proposed a step-criteria where if the customer has the opportunity to purchase the product warranty separately then the warranty would have a separate performance obligation (revenue deferral). If the customer does not have an option to separately purchase a product warranty, then judgement would be needed to determine if the warranty provides a service to the customer and would represent a separate performance obligation or whether the warranty represents a separate warranty obligation (cost accrual).
A FASB member questioned whether the separate purchase consideration would only be from the supplier or whether a third party would also be considered. The staffs responded that third parties would be considered under their recommendation but would have to be for the same product and same time period. Multiple IASB and FASB members had concern over the consideration of warranties offered by third parties. One IASB member referenced research he had performed on automobile warranties and that there were countless options all differing by level of coverage and length of term. He referenced the difficulties an entity would have in performing due diligence on the warranty products offered by competitors.
Several IASB and FASB members generally supported the proposals by the staff but requested the staff to supplement the proposed approach with additional application guidance. In particular, they noted examples of warranty arrangements which included service components (e.g., automobile warranties which include oil changes or brake replacements). The staff will take the feedback received during the meeting to further develop the proposals for a vote at a future meeting.