Question

Give an example of an assurance-type warranty and an example of a service-type warranty. Be specific: think about the types of warranties offered by businesses. I want real life examples.

In general, what are two key differences in these two types of warranties? Explain, explain, explain!

Answer 1

Solution:-

Give an example of an assurance-type warranty and an example of a service-type warranty:-

Vendor A manufactures and sells a model of luxury sports cars. Included in the car’s price is a five-year warranty that is two years longer than warranties provided by other car manufacturers; in addition, the law only requires Vendor A to provide a three-year warranty.

On January 1, 20X1, Vendor A sells a car to a customer for $200,000. The car’s estimated standalone selling price is $180,000, and the extra two years of warranty is $20,000. Vendor A delivers the car on January 1, 20X1 and the customer pays $200,000 on that same date. Based on past experience, Vendor A expects to incur $25,000 of warranty expense during the first three years of the car’s life and provide repairs evenly during the last extra two-year warranty period. How should Vendor A recognize revenue from this contract?

The five-year warranty is likely to contain both assurance- and service-type warranties. The first three years of the warranty is an assurance-type warranty because it is required by law. No revenue is allocated to this warranty. The two-year additional warranty should be classified as a service-type warranty for the following reasons: (1) the law only requires Vendor A to provide a three-year warranty; and (2) this warranty is longer than other warranties provided in the same industry. Vendor A should allocate $20,000 of the transaction price to the extended warranty. It should recognize revenue ratably over the two-year warranty period because on average, repair service is provided evenly over the two-year period for all customers. Vendor A would make the following entry on January 1, 20X1:

The table below illustrates the timing of revenue transaction for this contract:

what are two key differences in these two types of warranties:-

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. Therefore, an entity should allocate the transaction price to the product and the service. 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.

It is common for an entity to provide (in accordance with the contract, the law, or the entity's common business practices) a warranty in connection with the sale of a product (whether a good or a service). The nature of a warranty can vary significantly across industries and contracts. Some warranties provide a customer with assurance that the related product will function as the parties intended because it complies with agreed-upon specifications. Other warranties provide the customer with a service in addition to the assurance that the product complies with agreed-upon specifications.