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CFA Level I · CFA Level I Exam · Analyzing Balance Sheets

Under IFRS, a company sells products with a one-year warranty. Based on past experience, it is probable that some warranty claims will arise, and the amount can be estimated reliably. The company most likely should:

The company should recognize a provision at the best estimate of the expected cost. The sale creates a present obligation, an outflow is probable, and the amount is reliably estimable, so IAS 37 requires recognition rather than mere disclosure or waiting until claims are paid.

  1. ADisclose a contingent liability only
  2. BRecognize a provision at the best estimate of the expenditureCorrect
  3. CRecognize the cost when claims are actually paid

Explanation

IAS 37 requires a provision when there is a present obligation from a past event, an outflow is probable, and the amount can be reliably estimated. Warranty obligations meet these criteria at the time of sale. Recognizing costs only when paid is the cash approach and ignores the obligation. Disclosure alone is for possible obligations or those not reliably measurable.

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