E-Handout On Accounting For Warranties and Premiums

ACCOUNTING
LESSONS
WITH BCV
Accounting for Warranties and Premiums
Speaker: Brian Christian S. Villaluz, CPA, MBA
August 10, 2022 | 2:00PM – 3:00PM
Warranties
(Lifted from IFRS 15 Revenue from Contracts with Customers)
B28 It is common for an entity to provide (in accordance with the contract, the law or the entity’s customary business practices)
a warranty in connection with the sale of a product (whether a good or 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.
B29 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 shall account for the
promised warranty as a performance obligation and allocate a portion of the transaction price to that performance obligation.
B30 If a customer does not have the option to purchase a warranty separately, an entity shall account for the warranty in
accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets unless the promised warranty, or a part of
the promised warranty, provides the customer with a service in addition to the assurance that the product complies with
agreed-upon specifications.
B31 In assessing whether a warranty provides a customer with a service in addition to the assurance that the product complies
with agreed-upon specifications, an entity shall consider factors such as:
(a) Whether the warranty is required by law—if the entity is required by law to provide a warranty, the existence of
that law indicates that the promised warranty is not a performance obligation because such requirements typically
exist to protect customers from the risk of purchasing defective products.
(b) The length of the warranty coverage period—the longer the coverage period, the more likely it is that the promised
warranty is a performance obligation because it is more likely to provide a service in addition to the assurance
that the product complies with agreed-upon specifications.
(c) The nature of the tasks that the entity promises to perform—if it is necessary for an entity to perform specified
tasks to provide the assurance that a product complies with agreed-upon specifications (for example, a return
shipping service for a defective product), then those tasks likely do not give rise to a performance obligation.
B32 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 shall
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 shall account for both of the warranties
together as a single performance obligation.
B33 A law that requires an entity to pay compensation if its products cause harm or damage does not give rise to a performance
obligation. For example, a manufacturer might sell products in a jurisdiction in which the law holds the manufacturer liable
for any damages (for example, to personal property) that might be caused by a consumer using a product for its intended
purpose. Similarly, an entity’s promise to indemnify the customer for liabilities and damages arising from claims of patent,
copyright, trademark or other infringement by the entity’s products does not give rise to a performance obligation. The
entity shall account for such obligations in accordance with IAS 37.
ACCOUNTING
LESSONS
WITH BCV
Problem 1:
The Best Buy Company started its business in selling laptops with three-year warranty. It estimates its warranty cost as a percentage of
peso sales. Based on past experience, it is estimated that 2% will be repaired during the first year of warranty, 4% will be repaired during
the second year of warranty and 6% will be repaired in the third year.
In 2022 and 2023, the company was able to sell 8,000 units and 9,200 units, respectively at a total price of P 13,750 per unit. The
company paid actual repair costs of P975,000 and P4,000,000 in 2022 and 2023, respectively. The selling price of the warranty is P1,250
per unit. The laptop is selling at P12,500 if without the warranty.
Case 1: The warranty is an assurance-type warranty.
Required: Prepare the journal entries to record the foregoing and determine the following–
1. How much is the warranty expense to be reported for 2022?
2. What is the balance of the warranty liability on December 31, 2022?
3. How much is the warranty expense to be reported for 2023?
4. What is the balance of the warranty liability on December 31, 2023?
Case 2: The warranty is a service-type warranty.
1. How much is the sales revenue to be reported for 2022?
2. How much is the warranty income for 2022?
3. How much is the profit on warranty for 2022?
4. How much is the balance of the unearned income from warranty contracts on December 31, 2022?
5. How much is the sales revenue to be reported for 2023?
6. How much is the warranty income for 2022?
7. How much is the profit on warranty for 2023?
8. How much is the balance of the unearned income from warranty contracts on December 31, 2023?
Premiums
Companies offer articles of value such as toys, dishes, etc. to customers as a way of stimulating product sales. Such articles are called
premiums and should be accounted for under PFRS 15 Revenue from Contracts with Customers. The allocation of the transaction price
is based on stand-alone selling prices of the products sold and the premiums expected to be distributed as a result of such sales.
Problem 2:
Beginning year 2022, San Michael Brewery Inc. began marketing a new beer called “White Horse”. Each bottle of beer sells for P75. To
help promote the product, the management is offering a special beer mug to each customer for every 20 bottles of White Horse. The
entity estimates that out of the 300,000 bottles of White Horse sold during 2022, only 30% of the bottles will be redeemed. For the year
2022, 5,000 beer mugs were purchased by the company for P70 per mug. These beer mugs have a unit sales value of P100. A total of
4,000 mugs were distributed to the customers during 2022.
1. How much is the revenue from sale of White Horse for 2022?
2. How much is the premium income for 2022?
3. How much is the profit on premiums for 2022?
4. What is the balance of the unearned income from premiums on December 31, 2022?
5. What is the premium inventory balance on December 31, 2022?
Additional case: Account for the foregoing prior to the implementation of PFRS 15 Revenue from Contracts with Customers.
-END OF HANDOUT-

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ACCOUNTING

Case 1: The warranty is an assurance-type warranty.

Case 2: The warranty is a service-type warranty.

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