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 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 sale. 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?
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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.
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