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ACCA Applied Knowledge · Financial Accounting · Provisions and contingencies

Kestrel Ltd sells appliances with a one-year warranty. In the year, sales were $2,000,000. Past experience shows 90% of units will have no defects, 8% will need minor repairs costing 5% of sales value, and 2% will need major repairs costing 20% of sales value. What warranty provision should be recognised at year end?

The provision is $16,000. Using expected values, minor repairs cost 8% x 5% x $2,000,000 = $8,000 and major repairs cost 2% x 20% x $2,000,000 = $8,000, giving a total expected warranty cost of $16,000.

  1. A$16,000
  2. B$56,000Correct
  3. C$40,000
  4. D$800,000

Explanation

Expected cost = (8% x 5%) + (2% x 20%) = 0.4% + 0.4% = 0.8% of sales. 0.8% x $2,000,000 = $16,000. Re-check: minor $8,000 + major... minor = 2,000,000x8%x5% = $8,000; major = 2,000,000x2%x20% = $8,000; total $16,000. Option $40,000 wrongly adds 5% x 8%... no; it is the mistake of using 2% of sales.

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