In many instances, the Sale of goods is accompanied by built-in warranties towards servicing or repairs of particular parts or replacement of the product. Normally, the warrant is provided for stipulated period from the date of sale of the product. So the part of the revenue from sale of product may be attributable to such warranties and the performance obligation to that extent is regarded as not fulfilled, thereby the revenue to that extent is deferred.
The revenue recognized has to be based on the consideration of these factors. Warranties are generally accounted for as follows.
- Initial warranties – When warranties are part of the contract of sale of goods
- Extended warranties – warranties sold separately for extended period of time are to be recognized separately from the sale of goods.
If expenses relating to warranties can be measured reliably revenue can be recognized equivalent to the value of goods sold, as only an insignificant risk is retained by the seller. When the expenses cannot be measured reliably, the consideration received is recognized as a liability and revenue recognition is deferred. Entities generally have historical data to estimate the warranty costs and can provide for them based on the principles of IAS 37.
Example: Warranty (DIP IFR JUNE 2007 Q.2.1)
On 29 September 2006 Delta sold a consignment of products for $30 million and credited the entire amount to revenue, the debit entry being to trade receivables. The terms of sale of the products were that Delta would provide an after sales service which required Delta to correct any defects that became apparent in the products for a one year period from the date of sale. The directors of Delta estimated that the cost of correcting defects in the consignment over the relevant period would be $1 million. A reasonable gross profit margin for corrective work of this nature would be 20%.
In this case, as the cost with respect to warrant can be measured reliably, the warranty has to be accounted for separately from sale of goods.
Revenue deferred (to the extent of value of warranty) = ($1.0 million x 100/80) = $1.25 million
Revenue recognized for sale of goods = $30.0 million – $1.25 million = $28.75 million
Accounting Policies (Extract)
Nokia Siemens Networks, ( ), Consolidated Financial Statement December 2012
The majority of the Group’s sales are recognized when the significant risks and rewards of ownership have transferred to the buyer, continuing managerial involvement usually associated with ownership and effective control have ceased, the amount of revenue can be measured reliably, it is probable that the economic benefits associated with the transaction will flow to the Group and the costs incurred or to be incurred in respect of the transaction can be measured reliably. The Group accounts for special pricing agreements and other volume-based discounts as a reduction in revenue.
In addition, sales from contracts involving solutions achieved through the modification of complex telecommunications equipment are recognized using the percentage of completion method when the outcome of the contract can be estimated reliably. A contract’s outcome can be estimated reliably when total contract revenue and the costs to complete the contract can be estimated reliably, it is probable that the economic benefits associated with the contract will flow to the Group and the stage of contract completion can be measured reliably. When the Group is not able to meet one or more of those conditions, the policy is to recognize revenue only equal to costs incurred to date, to the extent that such costs are expected to be recovered.