How should standard warranty treatment be accounted for?

The correct choice reflects the appropriate accounting treatment for standard warranties, which is to recognize them as a provision based on estimated repair costs. Under applicable accounting standards, specifically IAS 37 - Provisions, Contingent Liabilities and Contingent Assets, entities are required to recognize a provision when they have a present obligation (legal or constructive) as a result of a past event, which in this case is the sale of goods with a warranty.

When a product is sold with a warranty, the company has an obligation to repair or replace the product if it fails within the warranty period. Therefore, the expected costs associated with fulfilling this warranty obligation must be estimated and recognized as a liability (provision) in the financial statements at the time of the sale. This ensures that the expense is matched with the revenue generated from the sale, providing a more accurate representation of the company’s financial position and performance.

This approach also complies with the matching principle, which states that expenses should be recognized in the same period as the related revenues. By accounting for warranty costs in this manner, businesses can better prepare for future cash outflows related to warranty claims, reflecting a realistic view of their liabilities.

Recognizing warranties as a separate revenue stream would not be appropriate as warranties