A manufacturer sells industrial equipment along with a warranty that, in addition to fixing any defects present at the time of sale, also includes scheduled preventive-maintenance visits and consumable-parts replacement for two years, services the customer would otherwise have to purchase separately from a third party. Under ASC 606-10-55-33, how should the manufacturer account for this warranty?
- Ignore the preventive-maintenance and consumable-parts elements entirely and account for the whole warranty as an assurance-type warranty under ASC 460
- Recognize the entire transaction price for the equipment and the warranty together at the moment the equipment is delivered
- Defer all revenue related to the equipment sale until the two-year warranty period has fully expired
- Account for the portion of the warranty that provides a service beyond fixing existing defects as a separate performance obligation, and allocate a portion of the transaction price to it, recognized as that maintenance and parts-replacement service is provided
Why D? And why not the others?
Correct answer: D. Account for the portion of the warranty that provides a service beyond fixing existing defects as a separate performance obligation, and allocate a portion of the transaction price to it, recognized as that maintenance and parts-replacement service is provided
ASC 606-10-55-33 explains that when a warranty, or a part of a warranty, provides the customer with a service beyond assurance that the delivered product complies with agreed-upon specifications, the promised service is a distinct, additional performance obligation, and the entity allocates a portion of the transaction price to it, recognizing that portion as the additional service is performed; here, the scheduled preventive maintenance and consumable-parts replacement go beyond fixing pre-existing defects and are services the customer would otherwise buy separately, so that service-type element must be split out and accounted for as its own performance obligation. Treating the whole arrangement as a pure assurance-type warranty under ASC 460 ignores that the preventive-maintenance and parts-replacement elements are additional services, not merely a promise that the equipment is defect-free, which is exactly what distinguishes a service-type warranty from an assurance-type one. Recognizing the full transaction price for both the equipment and the warranty at delivery ignores that the service-type warranty portion has its own performance obligation satisfied over the two-year service period, not at the point the equipment changes hands. Deferring all revenue on the equipment until the warranty period expires conflates the timing of the equipment's own performance obligation, generally satisfied at delivery, with the separate, later-satisfied service-type warranty obligation; the two are recognized on their own separate timelines, not bundled into a single deferred amount.
Source: FASB Accounting Standards Codification: ASC 606-10-55-33, Revenue from Contracts with Customers — Warranties