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

Zeta plc sells equipment with a one-year warranty. At the reporting date, past sales have created a warranty obligation. Based on experience, 90% of items sold will have no defects, 8% will need minor repairs costing $200 each and 2% will need major repairs costing $1,000 each. Zeta sold 10,000 items in the year. Under IAS 37, what is the warranty provision?

The provision is $360,000. IAS 37 requires expected value for a large population of similar obligations such as warranties. Minor repairs cost $160,000 and major repairs $200,000, and the two amounts are added to give the best estimate of the settlement cost.

  1. A$360,000Correct
  2. B$1,000,000
  3. C$200,000
  4. D$1,600,000

Explanation

For a large population of similar items the provision uses expected values. Minor: 10,000 x 8% x $200 = $160,000. Major: 10,000 x 2% x $1,000 = $200,000. Total $360,000. Using only the most likely outcome (no defects) would give nil, and adding the full repair costs of every item is not appropriate.

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