Warranties are a commonly tested topic in Financial Reporting (FR). Similar to other standards, they have definition, recognition, measurement, and disclosure rules. As you learn the complexities of ASPE and IFRS frameworks, understanding how warranties are treated is needed to pass your CPA Canada exams. In this blog, we’ll look at how to solve warranty AOs, with the key differences between IFRS and ASPE.

Example of a Warranty AO

For example, consider that as of September 1, 202X, Entity A must, by law, provide a 3-year warranty on all appliances sold. This warranty is not sold separately and ensures that Entity A will replace any appliances that do not meet product specifications over this period.

Records of historical sales indicate that over the past 5 years, most appliances incur defects within the first 2 years following the sale. It is estimated that 15% of appliances will incur defects and need replacement within the warranty period.

The estimated warranty cost for appliances sold between September and December 202X is $950,000 at an average of $2,000 per unit. Expenses totaling $15,000 are related to warranty claims on these sales. The average warranty cost per unit is $300.

Solving Using IFRS

Nature of Warranty

The first step to assessing this issue, is to identify the nature of the warranty, and whether this should be accounted for as revenue or as a provision.

As per IFRS 15, there are two types of warranties:

1. Warranties that give customers assurance that the product will operate as intended by both parties, as it adheres to agreed specifications.
2. Warranties that provide the customer with a service in addition to the assurance that the product complies with agreed-upon specifications. 

If the following criteria are both met, the warranty should be assessed using provision and contingency standards. If one, or both, criteria are not met, the warranty should be assessed using revenue standards.

1. The warranty can’t be purchased separately by the customer. – MET, the example indicates that Entity A does not sell this warranty separately
2. The warranty doesn’t provide a service to the customer in addition to the assurance that the product complies with agreed-upon specifications. To assesses this, you can consider the following factors:
   • The warrant is required by law – if the warranty is required by law, this supports that the warranty is not a separate performance obligation.
   • The warranty period – A longer period of coverage supports that the warranty is a separate performance obligation.
   • The nature of the warranty tasks promises – Certain tasks such as return shipping related to the defective product supports that the warranty is not a separate performance obligation.

• MET, Entity A is required by law to provide this warranty and no additional services are provided.

Because both criteria are met, the next step is to assess the provision using IFRS provision and contingency standards within IAS 37.

Definition

A provision is a liability of uncertain timing or amount. To assess this definition, we need to assess the following criteria:

1. Is this a liability?
   • A present obligation – MET, the warranty is an obligation required by law to fix or repair issues with appliances.
   • Arises from past events – MET, the appliances have been sold
   • Expected outflow of resources – MET, will require economic resources to provide a new appliance or repair the existing one
2. Uncertain timing or amount – MET, the amount of the warranty spend is uncertain as this depends on the volume of claims and the cost to resolve each, and the timing is uncertain over the course of the warranty coverage period.

Therefore, the definition is met.

Recognition

Under IFRS, a provision should be recognized when the following criteria are met:

1. There is a present obligation resulting from a past event – MET, the event occurred in the past.
2. Probable outflow of economic resources will be required to settle the obligation – MET, based on historical trends provided, defects typically occur within the first 2 years so it is likely claims will occur that will require economic resources from Entity A to resolve it
3. The obligation can be reliably estimated – MET, historical trends as per the above assessment can be used

Therefore, the warranty provision should be recorded.

Measurement

A provision should be recognized at the best estimate to settle the obligation. If there is an effect of time value of money, a present value should be determined.

The estimated warranty cost currently is – $950,000

The expected expenses already incurred for the warranty claims – $15,000

The difference, and present value of the warranty expense and provision is $935,000.

Conclusion

The provision for the warranty of $935,000 should be recorded as of December 31st.

(Note to students: In this example, we solved the problem in a very detailed way to help you understand the warranty concept. In your CPA Canada exam, depending what module you’re taking – Core 1, Assurance, CFE Day 2, CFE Day 3 – the amount of depth and details you need to write will be different.)

Solving Using ASPE

Under ASPE, there isn’t a dedicated section to discuss warranties. ASPE 3290 for contingencies can instead be applied to warranty scenarios.

Definition

A contingency exists where there is an existing condition that involves uncertainty to a possible gain or loss to the company, which will be resolved by a future event. The following criteria should be assessed:

1. Existing condition – MET, Entity A is committed to replacing defective appliances and these appliances have already been sold.
2. Possible gain or loss – MET, it is uncertain how many appliances will be returned and need to be replaced so there is uncertainty about the extent of the cost
3. Resolved by a future event – MET, uncertainty will be resolved as appliances are returned, or after the 3-year warranty coverage has passed.

Therefore, this meets the definition of a contingent loss. 

Recognition

Under ASPE, a contingent loss should be recognized in the financial statements when the following criteria are met:

1. It is likely that the loss will occur – MET, Entity A estimates that 15% of appliances will be defected during the warranty period.
2. The amount of the loss can be reasonably estimated – MET, the average cost of replacing each appliance is $300.

Therefore, since the amount can be estimated and is likely, a contingent loss should be accrued for 15% of appliances sold in the financial statements.

Measurement

Under ASPE, the minimum amount is used for an estimate. Because a range is not provided, we will use the best estimate. Given that 475 units ($950,000 / $2,000 per unit) were sold between September and December 202X, and 15% are likely to be defective during the warranty period, this means approximately 71 units (475 units x 15%) will be defective. At an average warranty cost of $500 per unit, this is a total warranty cost of $35,500. Since $15,000 of warranty costs have been incurred, the remaining balance is $20,500.

Conclusion

A contingent loss for the warranty of $20,500 should be recorded as of December 31st.

Key Differences

The main differences between the two include:

• IFRS assesses the nature of the warranty, to determine if it should be assessed using revenue or provision criteria.
• Under ASPE, the term contingent liability is used opposed to the term provision.
• Under ASPE, instead of taking the best estimate or range for measurement, the minimum amount is used.

Overall, under both methods, be sure you are addressing the definition and recognition criteria, and then calculating a measurement of the warranty impact. Be sure to integrate case facts when assessing these criteria to achieve depth! For more information on provisions and contingencies, click here.

Refer to ASPE vs IFRS for other standards that are unique or similar under the two frameworks.

Extra resources

I’m Gevorg. I’m an instructor and CPA Canada exam coach. If you want CPA Canada exam tutoring, sign up for CPA Review courses, for a comprehensive learning package.