Defects liability and warranties

A contractor's obligations do not end when the client moves in. Defects appear, and some, such as structural or fire safety faults, surface years later and cost far more than the original margin. This guide explains how defects provisions are estimated, when warranties are a separate service, and how latent defects and industry-wide remediation obligations are handled.

By Hamza Fida, Chartered Accountant. Reviewed by Mirza Fahad Baig, Chartered Accountant. 3 minute read.

Short answer

Defects liability in construction is the contractor's obligation to fix faults that appear after completion, during a defects period of typically one or two years, and in some countries for much longer under statute. Under IFRS, a standard obligation to remedy defects is an assurance-type warranty: the contractor provides for the expected cost under IAS 37 as the work is done. Maintenance or performance services beyond fixing defects are a separate performance obligation under IFRS 15. In this guide's example, contracts completed with revenue of 50 million need a general provision of 0.4 million and a specific provision of 0.25 million.

At a glance

Defects period
Typically 1 to 2 years
Standard obligation
Assurance warranty, IAS 37
Extra services
Separate obligation, IFRS 15
Estimate
History plus known defects
Latent defects
Can arise years later
Recoveries
Separate asset when virtually certain
Defects liability and warrantiesDefects period: Typically 1 to 2 years; Standard obligation: Assurance warranty, IAS 37; Extra services: Separate obligation, IFRS 15; Estimate: History plus known defects; Latent defects: Can arise years later; Recoveries: Separate asset when virtually certain.KEY FACTS AT A GLANCEDefects liability and warrantiesDefects periodTypically 1 to 2 yearsStandard obligationAssurance warranty, IAS37Extra servicesSeparate obligation, IFRS15EstimateHistory plus knowndefectsLatent defectsCan arise years laterRecoveriesSeparate asset whenvirtually certainTax BakersDefects liability and warrantiesDefects period: Typically 1 to 2 years; Standard obligation: Assurance warranty, IAS 37; Extra services: Separate obligation, IFRS 15; Estimate: History plus known defects; Latent defects: Can arise years later; Recoveries: Separate asset when virtually certain.KEY FACTS AT A GLANCEDefects liability and warrantiesDefects periodTypically 1 to 2 yearsStandard obligationAssurance warranty, IAS 37Extra servicesSeparate obligation, IFRS 15EstimateHistory plus known defectsLatent defectsCan arise years laterRecoveriesSeparate asset when virtually certainTax Bakers
Key facts at a glance, as set out in this guide.

Defects liability: an example provision

A contractor completed projects with total revenue of 50 million in the year. Over the past five years, defects work has cost about 0.8% of revenue. At the year end, it also knows of a leaking roof on one completed building that will cost 0.25 million to repair.

Construction obligations after completionConstruction obligations after completionStandardAccountingFix defects indefects periodIAS 37Provision aswork is doneMaintenanceservicesIFRS 15DeferredrevenueLatent defectsfound laterIAS 37Provision whenidentifiedPossible claimsIAS 37Contingentliability
Fixing defects is a cost; extra services are revenue.
ProvisionCU millionBasis
General defects provision0.400.8% of revenue, from experience
Specific provision: leaking roof0.25Estimated repair cost
Total0.65

The general provision builds up as work is done, because the contract's revenue has been recognised and the expected cost of making good is part of fulfilling it. It is released as the defects periods expire, and costs actually incurred are charged against it.

How is the general defects rate estimated and reviewed?

From the contractor's own history, analysed by type of work: defects on a hospital's building services differ from those on a road. The rate is adjusted for new methods, materials or subcontractors without a track record, and for known problems on recent projects. At each reporting date the contractor compares the costs actually incurred with the provision released, and changes the rate if experience has moved. Where defects periods or statutory liability run for several years, the provision is discounted if the effect of the time value of money is material.

Can defects reduce revenue instead of increasing costs?

Yes, where the contract lets the client deduct amounts from the price for defects or underperformance, such as a price reduction for a building that misses an energy rating. Those deductions are variable consideration under IFRS 15 and reduce the transaction price, in the same way as liquidated damages. The cost of the contractor's own remedial work stays a cost, provided for under IAS 37.

When are construction warranties a separate service?

A defects obligation that only assures the work meets the agreed specification is not a separate performance obligation. A promise to maintain the building, operate plant or guarantee performance beyond the specification, such as a ten-year maintenance contract for a hospital's systems, is a service: part of the price is allocated to it and recognised as it is provided. Contracts for infrastructure under public-private partnerships often include long operation and maintenance services.

How are latent defects handled?

Some defects, such as structural or fire safety failures, appear long after the defects period. Statutes in many countries, such as the ten-year decennial liability in several civil law jurisdictions, extend the contractor's responsibility. A provision is recognised when an obligation exists and an outflow is probable, typically once a defect has been identified and the contractor is responsible. Industry-wide commitments, such as UK developers' undertakings to fix unsafe cladding on buildings they built, have created obligations to provide for buildings completed many years earlier.

What about recoveries from subcontractors and insurers?

Where a subcontractor caused the defect or insurance covers it, the expected recovery is recognised as a separate asset only when it is virtually certain to be received, and never netted against the provision in the balance sheet.

How do defects interact with retentions?

The client usually holds part of the retention until the defects period ends. Defects the contractor does not fix may be deducted from it, so contractors assess retentions and defects provisions together. See construction retentions.

What is disclosed?

The defects and warranty provisions and their movements, the main assumptions, and contingent liabilities for claims that are possible but not probable. See warranties: assurance or service, IAS 37 explained and construction accounting.

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Questions people ask

How are construction defects accounted for under IFRS?

A standard defects obligation is an assurance warranty: the expected cost of remedying defects is provided for under IAS 37.

When is a construction warranty a separate performance obligation?

When it provides a service beyond assuring the work meets the specification, such as maintenance or performance guarantees.

When are latent defects provided for?

When a present obligation exists and an outflow is probable, typically once the defect is identified and the contractor is responsible.

Can recoveries from subcontractors be netted against defects provisions?

No. They are a separate asset, recognised only when virtually certain.

Sources

Every fee, date and rule on this page was taken from these official and primary sources.

  1. IFRS Foundation: IAS 37 Provisions, Contingent Liabilities and Contingent Assets
  2. IFRS Foundation: IFRS 15 Revenue from Contracts with Customers

Rules and fees change. If you are reading this long after October 7, 2026, confirm the figures with the source before you rely on them.

ManufacturingWarranties: assurance or serviceConstructionRetentions and the financing componentConstructionConstruction accounting: the key IFRS issues

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