Warranty definition

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What is a Warranty?

A warranty is a guarantee related to the performance of non-financial assets that are owned by the party being guaranteed. A guarantee is frequently incurred in connection with the sale of goods or services to the party being guaranteed. If the warranty is related to a product, the party providing the guarantee normally replaces or repairs the product in question. If the warranty is related to a service, the party providing the guarantee usually provides a full or partial refund, or replacement services.

Examples of Warranties

Here are several examples of commonly applications of warranties:

  • Automobile warranty. A car manufacturer offers a 3-year or 36,000-mile warranty covering defects in materials or workmanship. If any covered parts fail within this period, the manufacturer will repair or replace them at no cost to the owner.

  • Appliance warranty. A refrigerator comes with a one-year limited warranty that covers parts and labor for repairs due to manufacturing defects. The warranty gives consumers confidence in the product’s reliability and protects them from early breakdowns.

  • Electronics warranty. A laptop is sold with a 90-day warranty that includes coverage for hardware malfunctions not caused by user damage. If the device fails within that period, the manufacturer will replace faulty components or issue a replacement unit.

  • Roofing warranty. A roofing contractor provides a 10-year workmanship warranty that covers leaks or issues resulting from improper installation. This warranty ensures the contractor remains accountable for the quality of their labor over an extended period.

  • Furniture warranty. A furniture retailer offers a five-year structural warranty on a sofa, covering frame breakage or joint separation. The warranty excludes wear and tear but reassures buyers of the product’s construction quality.

  • Software warranty. A software provider offers a limited warranty stating that the software will perform as described in the user manual for 30 days after installation. If the program fails to operate as warranted, the user may receive a replacement or refund.

What is the Profitability of Warranties?

Many manufacturers view the sale of a warranty as a major source of revenue, for the following two reasons:

  • Inherent profitability. The price at which a warranty is sold usually greatly exceeds the associated cost. This is due to information asymmetry, where the seller knows more about the cost of a warranty than the buyer.

  • Customer forgetfulness. Many customers forget that they have a warranty, and so never file any claims against the manufacturer.

How to Account for a Warranty

A warranty is a contingent liability, so the party providing it should record a liability and warranty expense when it records the associated sale of goods or services. As the selling party incurs actual warranty costs, it charges them against the liability account, which therefore declines over time. If there is a history of minimal warranty expenditures, there is no need to record a contingent liability in advance of actual warranty expenses.