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What is a warranty?

A warranty is a written contract between the seller (or original manufacturer) and buyer to repair or replace the item for a specified period of time. Each warranty contract will explicitly say what type of issues are covered.

For example, if the warranty was on a car, it would not cover and damage that was caused by the buyer (i.e. a crash). However, if the transmission or stereo stopped working, then that may be covered. Warranties typically have a time or volume component. So back to the car example, a car warranty might last for 5 years or 50,000 miles. Once that threshold is hit, the warranty is no longer in place and the seller is off the hook for any future issues.

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  • How is a warranty accounted for under revenue recognition rules?

    Warranties can either be purchased separately or will result as a component of the sale of an inventory item. If the warranty is purchased separately from the inventory (an additional purchase), they will need to be accounted for accordingly. If the warranty is purchased separately from inventory, it should be considered a separate service or item. This will be recorded by the issuer of the warranty as a separate obligation (liability). However, if the warranty cannot be purchased separately, it will not be considered a separate obligation. Often times, companies will offer customers assurance that the product or services that they are purchasing will work or be delivered as understood. For example, if a company sold a product for $100 and it includes a 2 year warranty that has a value of $20, the company would recognize $80 of revenue and $20 would be recorded to unearned warranty revenue. The warranty revenue would then be recognized over the 2-year period.