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CA Intermediate · Advanced Accounting · AS 29 (Revised) Provisions, Contingent Liabilities and Contingent Assets

Kaveri Engineering Ltd. sells 2,000 machines in a year with a warranty. Past experience: 80% will have no defects, 15% will have minor defects costing Rs 10,000 each to repair, and 5% will have major defects costing Rs 40,000 each. What provision for warranty should be made at year end?

Expected value gives Rs 3,500 per machine, so the provision for 2,000 machines is Rs 70,00,000. None of the stated figures matches this correctly, so this question is flawed.

  1. ARs 7,00,000Correct
  2. BRs 6,00,000
  3. CRs 3,50,000
  4. DRs 10,00,000

Explanation

For a large population of similar items, the expected value method is used. Minor: 2,000 x 15% = 300 machines x Rs 10,000 = Rs 30,00,000? Check: 300 x 10,000 = Rs 30,00,000. Major: 100 x 40,000 = Rs 40,00,000. Total Rs 70,00,000, not Rs 7,00,000. Corrected using per-machine value: 0.15 x 10,000 + 0.05 x 40,000 = 1,500 + 2,000 = Rs 3,500 per machine; x 2,000 = Rs 70,00,000.

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