A business that sells goods with a warranty, or allows customers to return them, makes a promise at the point of sale. Some of those promises will cost money later. FRS 102 section 21 requires a provision when there is a present obligation from a past event, an outflow is probable and the amount can be estimated reliably. For warranties, the past event is the sale; the obligation exists across the whole population of goods sold, even if no individual claim has been made yet.
Warranty provisions
Base the estimate on history, not on hope:
- Take sales still under warranty at the balance sheet date.
- Apply the proportion that has historically needed repair or replacement.
- Multiply by the average cost of a claim (parts, labour, carriage).
An appliance retailer has £400,000 of sales still within a one-year warranty. Historically 3% of units are claimed at an average cost of 25% of the sales price:
£400,000 × 3% × 25% = £3,000
| Account | Debit | Credit |
|---|---|---|
| Warranty costs (cost of sales) | £3,000 | |
| Warranty provision | £3,000 |
When a repair is carried out, charge it against the provision. At each period end recalculate the required balance and post only the movement. If the provision has been consistently too high or too low, update the percentages rather than carrying the error.
Statutory consumer rights, under which faulty goods must be repaired, replaced or refunded, create the same kind of obligation as a written warranty, so the provision should cover both.
Expected returns
Online retailers in particular sell goods that come back. If a customer has a right to return goods and the business expects a proportion to be returned, revenue for those goods is not really earned. Recognise a refund liability for the expected refunds, reduce revenue by the same amount, and recognise the goods expected back as an asset (at cost, less any loss in value) rather than as cost of sales.
| Account | Debit | Credit |
|---|---|---|
| Sales | £6,000 | |
| Refund liability | £6,000 | |
| Returns asset (goods expected back) | £2,500 | |
| Cost of sales | £2,500 |
Supplier reimbursements
Where the manufacturer reimburses the retailer for warranty work, record the reimbursement as a separate receivable when it is virtually certain, normally when the manufacturer has accepted the claim. It is never netted against the provision: the provision is the business’s own obligation, the reimbursement is a separate asset.
Tax and VAT
A general provision is deductible for corporation tax if it is calculated with sufficient accuracy under accounting standards, which is why a documented method matters. For VAT, a refund made by credit note reduces output VAT in the period the credit note is issued; free warranty repairs are not a new supply.
Disclosure
Medium-sized and larger companies show the movement in provisions in the notes. Small companies still need to be able to support the figure: keep the calculation, the claims history used and the reason for any change in percentages.
Credit notes for returned goods are covered in discounts and credit notes; other provisions in taxes payable and provisions.