Construction warranties

Construction warranties – This part relates to a complete explanation of IFRS 15 Revenue from contracts with customers in respect of Engineering & Construction contracts, see Revenue from Engineering & Construction contracts. Construction warranties Construction warranties Construction warranties Construction warranties 

Warranties may fall into several categories. If the contractor provides the customer with the option of purchasing the warranty separately, the warranty should be treated as a distinct performance obligation, and a portion of the transaction price would be allocated to it. Likewise, if the warranty provides additional services (such as a certain number of years of maintenance), that service component qualifies as a distinct performance obligation, and a portion of the transaction price would be allocated to it. Construction warranties

But if the warranty is solely an assurance-type warranty (that is, a warranty Construction warranties against latent defects), there is no distinct performance obligation, so any inherent warranty embedded in the contract would be reflected in the performance obligation for the respective good or service and would not be considered a separate performance obligation.

This will likely result in less diversity in the treatment of warranties across entities, since it will result in a more consistent use of a cost accrual approach to such warranties within contract costs.

Warranties are commonly included in contracts to sell goods or services, whether explicitly stated or implied based on the entity’s customary business practices. The standard identifies two types of warranties:

  • Warranties that promise the customer that the delivered product is as specified in the contract are called ’assurance-type warranties’. The Boards concluded that assurance-type warranties do not provide an additional good or service to the customer (i.e., they are not separate performance obligations). By providing this type of warranty, the selling entity has effectively provided a quality guarantee.

    For example, E&C entities often provide various warranties against construction defects and the failure of certain operating systems for a period of time. Under the standard, the estimated cost of satisfying these warranties is accrued in accordance with the current requirements in IAS 37.

  • Warranties that provide a service to the customer in addition to assurance that the delivered product is as specified in the contract are called ’service-type warranties’. If the customer has the option to purchase the warranty separately or if the warranty provides a service to the customer beyond fixing defects that existed at the time of sale, the entity is providing a service-type warranty. The Boards determined that this type of warranty represents a distinct service and is a separate performance obligation.

    Therefore, the entity will allocate a portion of the transaction price to the warranty based on the estimated stand-alone selling price of the warranty. The entity will recognise revenue allocated to the warranty over the period the warranty service is provided. Service-type warranties may be infrequent in the E&C industry.

What is the source of warranties?

Accrual accounting

The fundamental idea of accrual accounting is that revenues are recognized when the earnings process is complete and not necessarily when the goods or services are paid for. In many cases determining when the earnings process is complete is very easy.  A bar that lets patrons run a tab has a completed earnings process every time a customer is poured a drink. However in many businesses the completion of the earnings process is not so clear cut. Take the case of product sellers who offer warranties to purchasers.

Some kind of product warranty

Many if not most consumer goods are sold subject to some kind of product warranty. This includes everything from microwaves and computers to automobiles and trucks. Sales of products subject to warranties present yet another challenge to accrual accounting.

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