The document discusses accounting treatment of future warranty claims. It describes how warranties work and outlines alternative approaches used to estimate technical provisions, including methods used by general insurance actuaries and accounting professionals. The actuarial approach involves estimating reserves for claims incurred but not reported, reported but not paid, and not yet incurred. The accounting perspective requires recognizing a provision if a past event creates a probable future outflow that can be reliably estimated under Ind AS 37. Actuaries can help by estimating reserves, managing warranty data, analyzing claim frequencies and severities, and refining methodology to address sources of volatility.

2. 2
B Dash & Co
Chartered Accountants
www.bdashco.com

3. Accounting treatment of Future
Warranty Claims
• Warranty Claims: Concept and Characteristics
• Alternative Approaches for Estimating Technical
Provisions
• Estimating Technical Provisions: GI Actuary’s
Standpoint
• Estimating Technical Provisions: Accounting
Profession’s Standpoint
• Current Actuarial Involvement in Estimating Technical
Provisions
• Concluding Thoughts: Where Actuaries Can Add Value
• References

4. Warranty Claims: Concept and Characteristics
Warranty Claims – An Example
A company manufactures and sells washing machines. Under the terms of the sale
contract, the company undertakes to make good, by repair or replacement ,the
manufacturing defects that become apparent within two years from the date of
sale. Based on past experience it is probable that there will be some claims under
the warranties.
Issue: What is the amount of provision to be recognised for the warranty claims as
on a given reporting date?
It is common for an entity to provide (in accordance with the contract, the law or
the entity‘s customary business practices) a warranty in connection with the sale
of a product
Some warranties provide a customer with assurance that the related product will
function as per the agreed upon specifications. Such warranties are referred to as
“manufacturers’ warranties”.
Other warranties provide the customer with a service in addition to the assurance
that the product complies with the agreed upon specifications. Typically the
customer has the option to purchase this warranty separately. Such warranties are
called as “Extended Warranties” or “Extended Service Contracts”.
Manufacturer Warranties and Extended Warranties are widely used as marketing
tools in the automotive sector and in the “white goods” industries.
Warranties can be either short term [e.g.., one year] or long term [e.g.., two to
five years]

5. Alternative Approaches for Estimating Technical
Provisions
• Methods for reserving for warranty claims can range from the
simplest to the more complex
• Typically the simpler methods are used for estimating short term
warranty claim provisions. These methods include
 Prior year payments: Under this approach, a company reviews
payments from the prior year and assumes equal warranty expenses to
current year products. This method may be satisfactory for short term
warranties, but is inadequate if the product mix changes over time or if
a company experiences extensive product growth/decline.
 Payments per unit sold: This method is an improvement on the “prior
year payments” that recognizes not only volume changes but also cost
differences between products.
• For longer term warranties, such as those that cover
automobiles and other durable goods, the above methods
generally are inadequate because they reflect only recent
payment activity and ignore the fact that most warranty claims
take place near the end of the warranty period. Therefore
reserving approaches similar to what general insurance actuaries
use will be more appropriate.

6. Estimating Technical Provisions: GI Actuary’s
Standpoint
• From a GI Actuary’s standpoint, the reserve or
technical provision for warranty claims will be
equal to the sum of the following three
constituents:
Technical Provision for Warranty Claims
=
Reserve for Claims Incurred But Not Reported
Plus
Reserve for Claims Reported But Not Paid
Plus
Reserve for Claims not yet incurred

7. Estimating Technical Provisions: GI Actuary’s
Standpoint
In symbols, the technical provision for warranty claims
can be expressed as
IBNR + RBNP +URR
which in turn can be further expanded and rewritten as
IBNR+RBNB+UPR+AURR(or PDR)
where IBNR represents Incurred But Not Reported
Claims
RBNP represents Reported But Not Paid Claims
URR represents the Unexpected Risk Reserve
UPR represents the Unexpected Premium
Reserve
AURR represents the Additional Unexpired
Premium Reserve (AURR is also referred to as
PDR or Premium Deficiency Reserve)

8. Estimating Technical Provisions: GI Actuary’s
Standpoint
The RBNP reserve can be directly pulled from the reported
loss data
The IBNR can be estimated using conventional triangle based
actuarial techniques The reporting and settlement lags are
likely to be short in the case of warranty claims.
Estimating URR is more difficult particularly for the long
duration contracts.
In the US context, the Statement of Statutory Accounting
Principles 65 (SSAP65) -applicable to Warranty Insurers -
provides the following guidance for calculating the URR.
According to this statement URR as on an accounting date
must be the maximum of
1.The amount payable if all policyholders surrendered their
contracts for refund,
2.The sum over all in-force policies of the gross premium
times the expected fraction of ultimate losses not yet
incurred, and
3.The expected present value of future losses, from in-force
policies, not yet incurred.

9. Estimating Technical Provisions: Accounting
Profession’s Standpoint
• The Ind AS applicable to warranty claims provisions is Ind
AS 37: Provisions, Contingent Liabilities and Contingent
Assets.
• What is a “Provision” under Ind AS 37?
The Standard defines a provision as a liability of
uncertain timing and amount A provision shall be
recognised when
 an entity has a present obligation (legal or constructive) that
is a result of a past event
 It is probable that an outflow of resources embodying
economic benefits will be required to settle the obligation
and
 A reliable estimate can be made of the amount of the
obligation

10. Estimating Technical Provisions: Accounting
Profession’s Standpoint
• Is a provision for “Warranty Claims” required under
Ind AS 37 (Recognition Aspect)?
Appendix F which accompanies Ind AS37 clearly
states that a provision is required for warranty
claims.
The rationale is as follows:
Present obligation as a result of a past obligating event
– The obligating event is the sale of the product with a
warranty, which gives rise to a legal obligation.
An outflow of resources embodying economic benefits
in settlement – Probable for the warranties as a whole.
A reliable estimate of the obligation can be made on
past experience

11. Estimating Technical Provisions: Accounting
Profession’s Standpoint
• How is the amount of provisions determined
(Measurement Aspects)?
Paragraph 36 to 83 of Ind AS 37 deal with the
measurement aspect
The amount recognised as a provision shall be the
best estimate of the expenditure required to settle
the present obligation at the end of the accounting
period.
An entity can use the following techniques to
determine the best estimate of the amount of
provision
Weighted Average of all possible outcomes by their
associated probabilities
or
The single most likely outcome.

12. Estimating Technical Provisions- An Example from
Ind AS37
An entity sells goods with a warranty under which
customers are covered for the cost of repairs of any
manufacturing defects that become apparent within
the first six months after purchase.
If minor defects were detected in all products sold,
repair costs of Rs.1 million would result .
if major defects were detected in all products sold,
repair costs of Rs. 4 million would result.
The entity’s past experience and future expectations
indicate that for the coming year, 75% of the goods
sold will have no defects, 20% of the goods sold will
have minor defects and 5% of the goods sold will have
major defects.
Therefore the expected value of the cost of repairs is:
(75% of nil) + (20% of 1m) +(5% of 4m) = Rs 400,000

13. Estimating Technical Provisions: Accounting
Profession’s Standpoint
• How is the amount of provisions determined
(Measurement Aspects)?(continued)
The risks and uncertainties that inevitably surround
many events and circumstances shall be taken into
account in determining the best estimate of the
provision
Where the effect of the time value of money is
material, the amount of a provision shall be the
present value of the expenditures expected to be
required to settle the obligation.
The discount rate (or rates) shall be a pre tax rate (or
rates) that reflect(s) current market assessments of
the time value of money and the risks specific to the
liability. The discount rate(s) shall not reflect risks for
which future cash flow estimates have been adjusted
Future events that may affect the amount required to
settle an obligation shall be reflected in the amount of
a provision where there is sufficient objective evidence
that they will occur.

14. Estimating Technical Provisions: Accounting Profession’s
Standpoint
• What are the disclosures required under Ind AS37?
Paragraph 84 and 85 of the Standard deals with the
relevant disclosures
For each class of provision, an entity shall disclose:
The carrying amount at the beginning and end of the
period;
Additional provisions made in the period, including
increases to existing provisions;
Amounts used (i.e. incurred and charged against the
provision) during the period;
Unused amounts reversed during the period; and
The increase during the period in the discounted
amount arising from the passage of time and the effect
of any change in the discount rate.

15. Estimating Technical Provisions: Accounting Profession’s
Standpoint
• What are the disclosures required under Ind AS37?
(Continued)
An entity shall disclose the following for each class of
provision:
A brief description of the nature of the obligation and
the expected timing of any resulting outflows of
economic benefits;
An indication of the uncertainties about the amount or
timing of those outflows. Where necessary, an entity
shall disclose the major assumptions made concerning
future events ; and
The amount of any expected reimbursement, stating
the amount of any asset that has been recognised for
that expected reimbursement.

16. Example Under IND AS 37 for Qualitative Disclosures
• A manufacturer gives warranties at the time of sale
to purchasers of its three product lines. Under the
terms of the warranty, the manufacturer undertakes
to repair or replace items that fail to perform
satisfactorily fro two years from the date of sale. At
the end of the reporting period, a provision of Rs.
60, 000 has been recognised. The provision has not
been discounted as the effect of discounting is not
material. The following information is disclosed:
• A provision of Rs. 60,000 has been recognised for
expected warranty claims on products sold during
the last three financial years. It is expected that the
majority of this expenditure will be incurred in the
next financial year, and the balance amount will be
incurred within two years after the reporting period.

17. Current Actuarial Involvement in Estimating Technical
Provisions
• Actuaries are involved in estimating the provision for
warranty claims associated with automobiles, white
goods (like TV, washing machine, etc.) consumer
electronic appliances and medical equipment.
• The frequency -severity approach is used to
determine the expected aggregate claim cost
associated with the inforce contracts/transactions
on the valuation date. The frequency rates and the
severity amounts tend to vary [usually increase] over
the warranty term. The severity amounts are
adjusted for inflation if the warranty term extends
beyond one year from the date of valuation.

18. Current Actuarial Involvement in Estimating Technical
Provisions
• Practice of discounting is not widely prevalent
• Inputs made available by the client are often in
the form of the raw data like number of claims
reported, exposure data In terms of sales
volume, past data on failures over the warranty
term; the unit costs (like raw material, direct
labour and direct expenses) of repairing the
products. The actuary needs to convert these
inputs into frequency rates and severity
amounts over the warranty term.

19. Concluding Thoughts: Where Actuaries Can Add
Value
• Estimating IBNR Reserves for Warranty Claims
• Data Management: Capturing correct data including
transactional level data is important not only to estimate
warranty costs, but also to support quality control
reviews and monitor the performance of the key
business partners like the service providers.
Homogenising the data will be an important
consideration.
• Generating information on how often products break
(frequency) and how much each breakage
costs(severity). For large warranty programs such as
those run by auto manufacturers, such analyses can help
in identifying trends in frequency and severity over the
life of the warranty. For example, the frequency of auto
warranty claims generally increases as the warranty ages
and the resulting claim severity also may increase

20. Concluding Thoughts: Where Actuaries Can Add
Value
• Refining the methodologies used for calculating the best
estimate provisions. Where credible past data on
warranty claims is available it may be possible to fit
appropriate statistical distributions for claim cost
distributions can be used to estimate the expected
aggregate claim cost and the volatility of such claims
costs.
• Addressing sources of volatility in claims costs and their
impact on the provision for claims -the introduction of
new products modifications of existing products,
regulatory changes and coverage modifications are some
of the key drivers which increase the variability and
uncertainty of warranty costs.

21. References
• Richard l. Vaughan, The Unearned Premium Reserve
for Warranty Insurance, Casualty Actuarial Society E
– Forum, Fall 2014 – Volume 1
• Indian Accounting Standard (Ind AS) 37: Provisions
Contingent Liabilities and Contingent Assets
• Education Material on Indian Accounting Standards
(Ind AS) 37, The Institute of Chartered Accountants
of India
• Indian Accounting Standard (Ind AS) 115 :Revenue
from Contracts with Customers

22. Thank you
22
B Dash & Co
Chartered Accountants
www.bdashco.com