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26. From the aforesaid details, it is clear that assessee had a liability towards commissioning and performance guarantee to be discharged in future in respect of the sales effected by the assessee during the year under consideration, and in respect of which provisions to the extent of Rs. 24,70,000/- was made, restricting it to the amount of bank guarantee given for Rs. 24,55,000/-. The total after-sales expenditure towards warranty obligation incurred by the assessee during the first year of operation ending on 31.03.2006, and in subsequent periods ending on 31.03.2007 and 31.03.2008 are to the extent of Rs. 4,76,000/-, Rs. 25,79,797/-, and Rs.10,75,546/- respectively. The total sales made by the assessee in the year ended on 31.03.2006 to 31.03.2008 are to the extent ITA no. 4340/Del/2009 of Rs. 2,45,50,000/-, 99,80,000/- and Rs, NIL respectively. From the above it is clear that the assessee has been incurring after sales service expenses even in the year in which no sales has taken place because of the reasons that the warranty given by the assessee in the year of sale was in force during the period falling within the subsequent years. It is, thus, clear that the warranty clause is embedded in the sales of the goods itself. In other words, the warranty is integral part of the sale price of the modems supplied by the assessee or the warranty stood attached to the sale price of the product. Therefore, when whole of the sale is recognized as the revenue, a reasonable estimate of warranty provision is to be provided in the accounts so as to determine the true and real income of the assessee in the relevant year. This would also satisfy the criteria of matching concept. Under the matching concept, if the revenue is recognized the cost incurred to earn that revenue including warranty cost has to be fully provided for. When modems are sold and the warranty clause is an integral part of the sale price of the modem, then the assessee has to provide for such warranty cost in its accounts for relevant year, otherwise the matching concept fails. The past event of providing warranty as an integral part of sale has created a definite liability upon the assessee to be discharged within warranty period. Therefore, providing provision for warranty at certain percentage of the turnover ITA no. 4340/Del/2009 fulfills the accrual concept as well as matching concept. In the present case, there could not be possibility of any data of actual defects occurring to the goods being available of past years but the warranty expenses actual incurred by the assessee in the year under consideration as well as in the future years and the terms and conditions of supply order wherein warranty was provided to the customers with a bank guarantee to the extent of 10% of value of goods sold can be a best guiding factors to make a reasonable provisions for warranty expenses. In the present case, after making sensible estimate in one year on the basis of terms of sale, the surplus of provisions remaining after actual expenditure were incurred has been reversed and credited in the profit and loss account in the year in which the warranty period expires and the same has been offered to tax.

In this case, we are concerned with product warranties. To give an example of product warranties, a company dealing in computers gives a warranty for a period of 36 months from the date of supply. The said company considers following options : (a) account for warranty expense in the year in which it is incurred ; (b) it makes a provision for warranty only when the customer makes a claim ; and (c) it provides for warranty at 2 per cent. of turnover of the company based on past experience (historical trend). The first option is unsustainable since it would tantamount to accounting for warranty expenses on cash basis, which is prohibited both under the Companies Act as well as by the Accounting Standards which require accrual concept to be followed. In the present case, the Department is insisting on the first option which, as stated above, is erroneous as it rules out the accrual concept. The second ITA no. 4340/Del/2009 option is also inappropriate since it does not reflect the expected warranty costs in respect of revenue already recognized (accrued). In other words, it is not based on the matching concept. Under the matching concept, if revenue is recognized the cost incurred to earn that revenue including warranty costs has to be fully provided for. When valve actuators are sold and the warranty costs are an integral part of that sale price then the appellant has to provide for such warranty costs in its account for the relevant year, otherwise the matching concept fails. In such a case the second option is also inappropriate. Under the circumstances, the third option is the most appropriate because it fulfils accrual concept as well as the matching concept. For determining an appropriate historical trend, it is important that the company has a proper accounting system for capturing the relationship between the nature of the sales, the warranty provisions made and the actual expenses incurred against it subsequently. Thus, the decision on the warranty provision should be based on past experience of the company. A detailed assessment of the warranty provisioning policy is required particularly if the experience suggests that warranty provisions are generally reversed if they remained unutilised at the end of the period prescribed in the warranty. Therefore, the company should scrutinise the historical trend of warranty provisions made and the actual expenses incurred against it.