A manufacturer sells a machine with a warranty that only promises the machine will operate as specified in the sales agreement for one year, matching the type of warranty a regulator requires by law for that product category, with no additional service beyond fixing defects that existed at the point of sale. Under ASC 606-10-55-30, how should this warranty be accounted for?
- As a separate performance obligation, with part of the transaction price allocated to it and recognized as the warranty service is provided
- By recognizing the entire transaction price for both the machine and the warranty at the moment the warranty is legally required, rather than at delivery
- By deferring all revenue from the machine sale until the one-year warranty period fully expires
- It is not accounted for as a separate performance obligation; the entity instead accrues an expense and liability for expected warranty costs under other applicable guidance, such as ASC 460
Why D? And why not the others?
Correct answer: D. It is not accounted for as a separate performance obligation; the entity instead accrues an expense and liability for expected warranty costs under other applicable guidance, such as ASC 460
ASC 606-10-55-30 distinguishes an assurance-type warranty, which simply promises that a delivered product complies with agreed-upon specifications and often mirrors a legally required warranty, from a service-type warranty, which provides an additional service beyond fixing existing defects. An assurance-type warranty like the one described is not a separate performance obligation under ASC 606; instead, the entity accounts for it under other applicable guidance, typically accruing an expense and corresponding liability for expected warranty costs consistent with loss-contingency guidance such as ASC 460. Treating it as a separate performance obligation with allocated transaction price is the treatment reserved for service-type warranties that provide something beyond a defect-free-at-sale assurance, which this warranty does not do. Deferring all revenue on the machine until the warranty period expires ignores that the machine's performance obligation is satisfied at delivery (or over time if applicable) independent of the warranty, since the assurance-type warranty is not itself a distinct obligation delaying recognition. Recognizing the entire transaction price only once the warranty becomes legally required misunderstands the timing entirely — legal requirement is a factor used to classify the warranty as assurance-type, not a trigger date for revenue recognition, which instead follows the normal five-step model based on transfer of the machine.
Source: FASB Accounting Standards Codification: ASC 606-10-55-30, Revenue from Contracts with Customers — Warranties