how we should account for warranty expenses?

Question

All products sold by the company have a two year warranty for any manufacturing defects. . As the company is growing, this amount is becoming more material. Warranty claims eventually tend to be approximately 10% of total sales in the first year and 15% in the second year based on prior experience. I am not really sure what a provision is and if a provision can be recognised in the accounts before a claim is made, as the provision will not be accurate as we do not know what actual costs will be incurred. So, how we should account for warranty expenses?

Answer 1

You can make a provision under IAS 37 Provisions, Contingent Liabilities and Contingent Assets. They define a Provision as A liability of uncertain timing or amount. So you don't have to be worried if you don't know the actual amt.

Measurement of Provisions

The amount recognised as a provision should be the best estimate of the expenditure required to settle the present obligation at the balance sheet date, that is, the amount that an enterprise would rationally pay to settle the obligation at the balance sheet date or to transfer it to a third party. [IAS 37.36] This means:

* Provisions for one-off events (restructuring, environmental clean-up, settlement of a lawsuit) are measured at the most likely amount. [IAS 37.40]
* Provisions for large populations of events (warranties, customer refunds) are measured at a probability-weighted expected value. [IAS 37.39]

For warranties, it is usual to use historical data in your own company or industry data to arrive at the amt to provide.
Perhaps a reading of IAS 37 will give you better comfort.

Answer 2

Count on total replacement for every failed unit and simply swap out the failures.

That means marking up the product another 25%.

Repair warranty units as an off-peak return.

Also, kick the **** of manufacturing as a failure rate of 25% is unacceptable, a failure rate of 1% is normal.