Question

If the system bug fix is a contractual obligation, can the system bug fix be treated as an assurance warranty? Can it be seen as a separate performance obligation？

Answer 1

ASC 606 is the new revenue recognition standard that covers revenue from warranties in detail.

As per ASC 606, revenue recognition has been categorized into a 5 step process:

• Identify the customer contract
• Identify the performance obligations in the contract
• Determine the transaction price
• Allocate the transaction price to the performance obligations in the contract
• Recognize revenue when the entity satisfies a performance obligation

Warranties in the step 2 & 3 of the above process can be identified as an assurance warranty or service warranty. Assurance warranty provides assurance to the customer that the contracted product will perform based on the operational standards as defined in the contract. Service warranty are an addition to the above since they also provide a service in addition to assurance on the product.

Generally, an assurance warranty is not treated as a separate performance obligation since it's the objective of the contract to provide assurance on the product on pre-defined parameters. However, a service warranty can be treated as a performance obligation. Below are the excerpts of ASC 606 to provide more clarity in such situations:

• If a customer has the option to purchase a warranty separately (for example, because the warranty is priced or negotiated separately), the warranty is a distinct service because the entity promises to provide the service to the customer in addition to the product that has the functionality described in the contract. In those circumstances, an entity should account for the promised warranty as a performance obligation.
• If a warranty, or a part of a warranty, provides a customer with a service in addition to the assurance that the product complies with agreed-upon specifications, the promised service is a performance obligation. If an entity promises both an assurance-type warranty and a service-type warranty but cannot reasonably account for them separately, the entity should account for both of the warranties together as a single performance obligation.

Usually companies provide periodic bug fixes and updates from their end to all customers who've purchased their SaaS products or software licences. In such cases, the nature of it's performance obligations to provide unspecified bug fixes & updates is in the nature of "stand ready obligation".

If the nature of business is to provide periodic unspecified bug fixes and updates, it can be considered as a consistent performance obligation in line with the time-based measure of revenue recognition over the period of the contract on a straight-line basis.