Contracts entered into by entities that are not insurers may fall within the scope of the new insurance standard.
AASB 17 Insurance Contracts is the most significant new accounting standard to become effective since the last major new standard, AASB 16 Leases. It supersedes AASB 4 Insurance Contracts and fundamentally changes the way insurance contracts are accounted for. The new standard applies to annual reporting periods beginning on or after 1 January 2023.
Understandably, non-insurers may have given the new insurance standard very little thought on the basis that it will not apply to them. While this may be true in many cases, AASB 17 should not be completely ignored as some contracts that non-insurers enter into on a regular basis may fall within the scope of this complex new standard. This is because AASB 17 applies to insurance contracts regardless of the entity that issues them.
In a series of articles, we will explore the scope of AASB 17 with non-insurers in mind. The focus will be on key definitions and concepts, transactions that are explicitly carved out of the scope of the standard, and optional exemptions that allow certain contracts that meet the definition of an insurance contract to be accounted for under another accounting standard.
Part 3: Product warranties
Warranties are promises an entity makes about the quality of a product or service, or how it will fix any problems with a product or service, that it sells.
Insurance risk exists in product warranties because either the number of services to be performed or the nature of those services, or both, is uncertain. They protect the customer against an ‘uncertain future event’, and the risk may be significant. Consequently, product warranties normally meet the definition of an insurance contract and would therefore be caught by AASB 17.
The mandatory scope exclusion ensures extended warranties offered to customers by manufacturers, dealers or retailers at the time of sale of the goods or services are not subject to insurance accounting.
Judgement may be needed to determine whether a warranty is provided ‘in connection with’ the sale of goods or services to a customer as there is no guidance on this. Factors such as when the warranty is purchased by the customer and when the warranty is priced will need to be considered.
In a group situation where the parent entity sells the goods or services while a subsidiary offers the warranty, the scope exclusion would apply in the consolidated financial statements. However, in the subsidiary’s individual financial statements it would not apply because the warranty is provided by a party other than the manufacturer, retailer or dealer. The fixed fee contract criteria may apply in this case which means the subsidiary could choose to account for the warranties under AASB 15 Revenue from Contracts with Customers instead of AASB 17.
A white goods retailer provides its customers with a free two-year warranty to cover repairs due to manufacturing defects. In addition, for a fixed price, customers can purchase an additional one-year extended repair warranty. Both warranties are provided/offered at the time of sale of an appliance.
Question: Are the two warranties insurance contracts within scope of AASB 17?
No, as they meet the scope exclusion for warranties. Both warranties are available at the time of the sale and are provided by the retailer that sells the appliance.
Question: How would the assessment change if the one-year extended repair warranty is offered at a later date?
If the extended repair warranty is provided at a later date and not concurrently with the sale (i.e., the original sale terms did not allow for the subsequent purchase of the warranty at a fixed price), it is unlikely that the extended repair warranty will meet the scope exclusion for warranties.
This is because it fails the ‘in connection with the sale’ test.
Question: How would the assessment change if the one-year extended repair warranty is provided by a subsidiary in the same group and not by the entity that sells the appliances?
In this case, the warranty is provided by a party other than the manufacturer, dealer or retailer which means the scope exclusion for warranties would not apply in the individual financial statements of the subsidiary. That is, AASB 17 would need to be applied in the subsidiary’s financial statements (unless the fixed fee contract criteria are met). From a group perspective, however, the appliances and both warranties are provided by the same reporting entity therefore the scope exclusion for warranties would apply in the consolidated financial statements.
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