This post on fixed assets warranty accounting or product warranty accounting deals with the treatment of warranties in the bookkeeping records of a business purchasing a fixed asset such as property, plant or equipment.
When an asset is purchased the costs which are capitalized include both the cost of the asset itself and the costs incurred in bringing the asset to the location and working condition ready for its intended use, such as shipping, installation and testing costs.
The question arises as to whether or not fixed assets warranty costs can be treated as part of the capitalized cost of acquiring the asset.
For the purposes of this discussion fixed asset warranties are considered as either embedded or extended.
Embedded Fixed Assets Warranty
An embedded warranty is one which is included as part of the cost of the asset and not identified as a separate cost to the purchaser. For example the supplier might include a one year manufacturers warranty.
In these circumstances as far as the purchaser is concerned it is part of the cost of the asset itself and is simply capitalized in accordance with the above definition.
Extended Fixed Assets Warranty
An extended warranty is one which is is sold separately to the product itself. For example for an additional fee the supplier might sell an extended warranty to cover the product for a further two years after the embedded manufacturers warranty expires.
In this instance the purchase of the extended warranty protects the equipment in the future but is not necessary to enable the equipment to be brought into use.
In the circumstances the extended fixed assets warranty is not a cost incurred in ‘bringing the asset to the location and working condition ready for its intended use’ and therefore does not fall with the definition of costs which can be capitalized.
The extended warranty is however still an asset and in effect represents a deferred expense for the business.
Fixed Assets Warranty Example
A business purchases equipment costing 20,000 including a one year manufacturers warranty. In addition the business buys an extended fixed assets warranty for 600, valid for a period of 30 months after the manufacturers warranty expires.
Asset and Warranty Purchase
The embedded manufacturers warranty is included as part of the cost of the asset itself and is therefore capitalized. The extended warranty is a separate cost and does not fall within the definition of ‘bringing the asset to the location and working condition ready for its intended use’ and is treated as a deferred expense.
The deferred expense asset is shown below under the account referred to as extended warranties.
The bookkeeping journal to post the transaction is as follows.
Treatment of the Deferred Expense
After the period of one year the manufacturers warranty ends and the extended fixed assets warranty starts and then continues for a period of 30 months. Each month the amount utilized is transferred from the deferred expense account to the income statement.
The amount utilized each month is calculated as follows.
Extended warranty cost = 600 Term = 30 months Monthly expense = 600/30 = 20
The journal entry to post the expense is shown below.
This process continues for 30 months until the entire cost of the extended warranty has been transferred as an expense to the income statement.
Current or Long Term Asset
At the end of any financial year the amount of the extended warranty that will be used in the next 12 months is classified as a current asset and the amount to be used after 12 months is classified as a long term asset.
For example, if at the end of the financial year the balance on the extended warranty account is 400 then the amounts classified as a current and long term asset are calculated as follows.
Extended warranty cost = 600 Term = 30 months Monthly expense = 600/30 = 20 Extended warranty account balance = 400 Current asset = 20 x 12 = 240 Long term asset = 400 - 240 = 160
Obviously if the asset is disposed of before the extended fixed assets warranty has expired then the balance on the extended warranty account cannot be treated as an asset and must be transferred to the income statement as an expense.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.