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How to Account for an Extended Warranty [Video]

How to Account for an Extended Warranty

While a standard warranty against product defects is treated as a loss contingency, an extended warranty is treated as a separate performance obligation under U.S. GAAP.

This means that a company selling an extended warranty would initially record the cash received (or accounts receivable) from the customer and record unearned revenue (a liability). The company would not record revenue related to the extended warranty until a portion of the extended warranty period has elapsed.

For example, let’s say a company sells a product with a standard 3-year warranty, but the company also offers the customer the opportunity to purchase an additional 2-year warranty (extending the warranty period to 5 years in total) for the additional price of $200. If the customer purchases the extended warranty, the company would recognize the $200 as revenue over the course of years 4 and 5 (usually on a straight-line basis; thus, $100 of revenue would be recognized at the end of year 4 and $100 of revenue would be recognized at the end of year 5).

Any costs associated with the extended warranty would be recognized in the periods covered under the extended warranty; this is to ensure matching of the costs with the periods in which they generate revenue.

0:00 Standard warranty
1:30 Non-standard warranty
3:25 Example
4:14 Journal entry for standard warranty
4:50 Accounting for extended warranty
5:35 Journal entry for extended warranty
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