Is warranty expenses provision allowed/disallowed as an expense?
A warranty is an official assurance provided by the manufacturer to the purchaser of a product, committing to repair or replace it if necessary within a set time frame. As a consequence, it is a future expense that a manufacturer may or may not incur.
Warranty expense is defined as the cost of repairing, replacing, or compensating a user for any product problems. In other words, a vendor or manufacturer agrees to fix or replace a sold product if it breaks or fails to work properly according to the terms of the guarantee.
In the matter of Rotork Controla India (P) Ltd vs CIT, Chennai on 12 May, 2009 made the below decision given by Honorable Supreme court on following issue:
1. Normally we have three choice in the case of accounting treatment for warranty expenses incused by company:
a) we can make account for warranty expense in the financial Year in which it is warranty expenses has been incurred ;
(b) We can also makes a Accounting provision for warranty expenses only when the client has start makes a claim ; &
(c) We can also provide for warranty expenses as some % of our sale turnover of the company based on last historical trend.
2. Out of above all 3 options,
1st option is unsustainable because it will tantamount to accounting for warranty expenses on cash basis which is not appropriate.
2nd Option is also inappropriate because it does not appeared & reflect expected warranty costs in respect of sale or related revenue already incurred & recognized.
3rd option is the suitable & can say that it is most appropriate since, it fulfils accrual concept as well as the matching concept.
In this case Rotork Controla India (P) Ltd vs CIT, Chennai, the Hon'ble Supreme Court ruled in favour of the assessee and allowed for the deduction of the warranty provision, offering that the provision was created using scientific methodology and was not made arbitrarily.
Now you can say that, Warranty expenses should be used as some % of our sale turnover of the company based on last historical trend. Provision of warranty expenses should be established using a scientifically devised approach based on prior experience, taking into account elements such as previous year's company turnover and allowance for repair charges throughout the guarantee period. so Warranty expenses should created using scientific methodology and was not made arbitrarily.