Accounting for standard and extended warranties

2. Accounting for extended warranties by product seller or manufacturer

Extended warranties are agreements to provide warranty protection in addition to the scope of coverage of the manufacturer's original warranty, if any, or to extend the period of coverage provided by the manufacturer's original warranty.

Accounting for extended warranties differs from accounting for standard warranties described earlier.  When a company sells extended warranties, it is required that the sales amount of extended warranties be “deferred and recognized in income on a straight-line basis over the contract period except in those circumstances in which sufficient historical evidence indicates that the costs of performing services under the contract are incurred on other than a straight-line basis.”

In this case, an extended warranty represents deferred revenue.  It is still a liability, similar to standard warranty reserves; however, extended warranties become earned revenues over the coverage effective period and are fully recognized into revenue at the time extended warranty contracts expire.

Costs that are directly related to the acquisition of a contract and that would have not been incurred but for the acquisition of that contract (incremental direct acquisition costs) shall be deferred and charged to expense in proportion to the revenue recognized. All other costs, such as costs of services performed under the contract, general and administrative expenses, advertising expenses, and costs associated with the negotiation of a contract that is not consummated, shall be charged to expense as incurred.

Let us look at an example of accounting for extended warranty revenues.  Assume that Company ABC from the example earlier also sells extended warranties on gadgets XYZ.  Extended warranties go into effect after standard warranties expire (on the first anniversary of the gadget sale date) and cover the products for additional two years.  In our example, for the gadgets sold in May 20X3, extended warranties sold by the company amounted to $4,800.  The coverage period for the extended warranties is May 20X4 to April 20X5.  We will assume that there were no contract acquisition costs and that costs related to services under extended warranties are evenly distributed over the coverage period.  Each month during the coverage period, the company would recognize extended warranty revenues in the amount of 1/24th of $4,800 or $200.

The company sold $4,800 of extended warranties in May 20X3:

Account Titles

Debit

Credit

Cash

$4,800

 

     Deferred Extended Warranties

 

$4,800

The company starts recognizing extended warranties as revenues in May 20X4:

Account Titles

Debit

Credit

Deferred Extended Warranties

$200

 

     Extended Warranty Revenues

 

$200

Each month for the next 23 months the company would recognize $200 of revenues related to the extended warranties sold in May 20X3.

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