Question

Warranty costs are depreciated over the life of the warranty.

True or False

Answer 1

True

a. An embedded warranty is one which is included as part of the cost of the asset and not identified as a separate cost to the purchaser. For example the supplier might include a one year manufacturers warranty. In these circumstances as far as the purchaser is concerned it is part of the cost of the asset itself and is simply capitalized.

b. An extended warranty is one which is is sold separately to the product itself. For example for an additional fee the supplier might sell an extended warranty to cover the product for a further two years after the embedded manufacturers warranty expires. In this instance the purchase of the extended warranty protects the equipment in the future but is not necessary to enable the equipment to be brought into use.In the circumstances the extended fixed assets warranty is not a cost incurred in ‘bringing the asset to the location and working condition ready for its intended use’ and therefore does not fall with the definition of costs which can be capitalized.

The extended warranty is however still an asset and in effect represents a deferred expense for the business. It is to be recorded as deferred expenditure and it is to be written off during the warranty period.