Warranty in simple words is a promise by the manufacturer to make good of your loss under certain conditions. This helps win customers’ confidence and is one of the major consideration in buyer’s purchase process. Warranty offers comes in different forms such as simple warrant, extended warranty, replacement warranty, repair warranty, life time warranty etc.
Often the cost of warranty is added as price of the article itself and is not stated separately. But in rare cases of consumer goods it is offered separately and buyer can decided to purchase the item with or without warranty. And if it is purchased either as part of cost of the item or separately it is considered cost of purchase.
The above situation might be true in the daily life of a consumer. However, when it comes to business world we have to follow rules to see if it really qualifies for capitalization as cost of the asset. In business and accounting world this is issue is still under a debate as standards have to give clear cut treatment for different types of warranties. However we can classify warranties broadly in two ways:
- assurance type warranties e.g. if the product breaks down in 20 days from the date of purchase then free repair will be done. This warranty usually require no separate payment by the buyer and is included or covered or hidden in the cost of the asset itself. Therefore, buyer does not require any separate treatment for such warranty
- extended warranties e.g. also termed as after sales service or simply service type warranty most of the time require buyer to pay in addition to purchase price of the asset. In such case it is not capitalized and is deferred and reduced over the warranty term.
According to IAS 16 Property Plant and Equipment para 16 only the following cost can be included:
- cost of purchase adjusted for duty, discounts, taxes and rebates etc
- directly attributable cost necessary to bring the asset into its intended use
- estimated cost of dismantling and removing the asset
Extended warranty cost qualifies for none of the above three criteria and thus cannot be added as cost of the asset. Therefore it will be treated as expense in the relevant period and will be presented in the profit and loss account.
For example if the warranty cost is paid upfront for next three years then it is deferred and recongized as an expense on straight line basis over three years period.
The reason for treating warranty cost as expense is that warranty cost are not necessary to bring the asset into its intended use as asset can still be used even if warrant is not given or taken.