Software warranties

Software warranties – A customer may have the option to separately purchase a warranty on a product (e.g., computer hardware, networking equipment) for a period of time at the point of sale or the warranty may be explicitly stated in the contract. Software warranties Software warranties Software 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.

But if the warranty is solely an assurance-type warranty (that is, a warranty 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.

Entities may also provide maintenance services, such as bug fixes for a software licence, that may be considered to be a warranty. The standard identifies two types of warranties:

  • Warranties that provide a service to the customer in addition to assurance that the delivered product is as specified in the contract (service-type warranties)
  • Warranties that promise the customer that the delivered product is as specified in the contract (assurance-type warranties) Software warranties

If the customer has the option to purchase the warranty separately or if the warranty is not separately priced or negotiated, but provides a service to the customer beyond fixing defects that existed at the time of sale, the entity is providing a service-type warranty. This type of warranty represents a distinct service and is a separate performance obligation. Revenue related to the warranty is recognised over the period the warranty service is provided. Software warranties

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 (e.g., to replace or repair a defective product). Such warranties will continue to be accounted for in accordance with IAS 37.

If an entity provides both assurance-type and service-type warranties within an arrangement, an entity is required to accrue for the expected costs associated with the assurance-type warranty and account for the service-type warranty as a performance obligation. If the entity cannot reasonably account for them separately, the warranties are accounted for as a single performance obligation (i.e., revenue would be allocated to the combined warranty and recognised over the period the warranty services are provided). Software warranties

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.

Software warranties

Software warranties

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