How are warranties that provide free repairs treated?

Warranties that provide free repairs are treated as a separate performance obligation due to their nature of promising additional service beyond the mere transfer of goods. Under the revenue recognition principle, when a company sells a product that includes a warranty offering repair services, that warranty service is considered a distinct service. This means that the company must recognize revenue associated with the warranty when the warranty services are provided, rather than all at the time of sale.

This treatment reflects the obligation of the company to support the product post-sale, allowing them to allocate a portion of the transaction price to the warranty based on expected costs and the expected period during which the service will be provided. Effectively, this ensures that the revenue associated with the warranty aligns with the costs incurred in delivering that service, maintaining the matching principle in accounting.

Recognizing warranties as a separate performance obligation allows financial statements to appropriately reflect the company’s future commitments and the timing of revenue recognition, offering a clearer picture of the company's financial position and operational performance.