Question

A manufacturer provides warranties at the time of sale to purchasers of its product lines. Under the terms of the warranty, the manufacturer undertakes to repair or replace items that fail to perform satisfactorily within a period of two years from the date of sale. When should the manufacturer recognise the provision?

A. At the time of sale
B. At the end of the warranty period
C. When the company is notified of a claim
D. Never—a provision should not be recognised; rather the costs associated with the warranty should be expensed as incurred

Answer 1

The manufacturer should recognize the provision for warranties at the time of sale to comply with the matching principle of accounting.

Step-by-step explanation:

When a manufacturer provides warranties, it is a commitment to repair or replace products that do not perform satisfactorily within a set period, in this case, two years. According to accounting standards, the manufacturer should recognize the provision at the time of sale.

This is because the warranty is an obligation that arises as a result of past events, which is the sale of the product. The manufacturer has to estimate the costs of fulfilling the warranty and recognize these as a liability on the balance sheet and as an expense in the income statement when the product is sold.

Recognizing a warranty obligation at the time of sale ensures that the recognition of revenues from the sale of goods is matched with the expenses related to those revenues, such as future warranty claims. This practice adheres to the accounting principle known as the 'matching principle', where expenses are reported in the same period as the revenues they help to generate.