Extended Product Warranties

Question: Not all warranties are built into a sales transaction. Many retailers also provide extended product

warranties but for an additional fee. For example, assume a business sells a high-definition television with an

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automatic one-year warranty. The buyer receives this warranty as part of the purchase price. The accounting for

that first year is the same as just demonstrated; an estimated expense and liability are recognized at the time of


However, an additional warranty for three more years is also offered at a price of $50. If on January 1, Year One,

a customer chooses to acquire this three-year coverage, what recording is made by the seller?

Is an extended warranty purchased by a customer reported in the same manner as an automatic warranty

embedded within a sales contract?

Answer: Extended warranties, which are quite popular in some industries, are simply insurance policies. If the

customer buys the coverage, the product is insured against breakage or other harm for the specified period of time.

In most cases, the company is making the offer in an attempt to earn extra profit. The seller hopes that the amount

received for the extended warranty will outweigh the eventual repair costs. Therefore, the accounting differs here

from that demonstrated for an embedded warranty that was provided to encourage the sale of the product. Because

of the matching principle, the anticipated expense was recognized in the same period as the revenue generated by

the sale of the product.

By accepting money for an extended warranty, the seller agrees to provide services in the future. This contract is

much like a gift card. The revenue is not earned until the earning process is substantially complete in the future.