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ACCA Strategic Professional · Strategic Business Reporting (International) · Provisions, contingencies and events after the reporting period

Ordell Co sells goods with a warranty. Past experience suggests that of goods sold, 80% will have no defects, 15% will have minor defects costing $100 each to repair and 5% will have major defects costing $400 each to repair. Ordell sold 10,000 units in the year with warranty still running. What is the warranty provision under IAS 37?

The provision is $350,000. For a large population of similar warranty claims IAS 37 requires the expected value method, weighting each outcome by probability: $35 per unit across 10,000 units.

  1. A$350,000Correct
  2. B$1,500,000
  3. C$500,000
  4. D$3,500,000

Explanation

For a large population of similar items, expected value is used. Expected cost per unit = 15% x $100 + 5% x $400 = $15 + $20 = $35. Multiplied by 10,000 units gives $350,000. Using the most likely outcome (no defects) would give nil, and summing the per-defect costs without weighting overstates the provision.

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