XYZ Co sells goods with a one year warranty under which customers are covered for any defect that becomes apparent within a year of purchase. In calendar year 20X6, XYZ Co sold 25,000 units.
The company expects warranty claims for 4% of units sold. Half of these claims will be for a major defect, with an average claim value of $25. The other half of these claims will be for a minor defect, with an average claim value of $5.
What amount should XYZ Co include as a provision in the statement of financial position for the year ended 31 December 20X6?
Answer
XYZ Co should provide on the basis of the expected cost. The expected cost would be calculated as (2% x 25,000 x $25) + (2% x 25,000 x $5) = $12,500 + $2,500 = $15,000
Dr. warranty Expense…………..15,000
Cr. Provision for warranty…………………..15,000