Can Ltd sell goods carrying a two year repair warranty. The following expectations 

have been set by the Management for the year ended 31 October 2014

% goods sold Nature of defects Cost of repairs if items had 

defects

75% No defects R nil

18% Minor defects R200 000

7% Major defects R300 000

Required: Calculate the provision for warranty repairs and make journal entries:

Answer: Provision for warranty expense R57,000

Solution:

Step 1: Check the percentage for each warranties with its accompanied price.

No defects 75%

Minor defects 18% of R200 000

Major defects 7% of R300 000

1st 75% no defect, this means that all of the revenue recognized is 75% free from defect. For example, you have a R1,000,000 revenue, R750,000 of it has no defect. But the remaining R250,000 is not necessarily means to be defected. There should have been a certain percentage that is needed to multiply to get the exact defect. Say for example, 15%. With such, 15% x 250,000 will be R37,000.

Step 2: Multiply the defect percentage to its accompanied price

No defects 75% x 0 = R0

Minor defects 18% x R200 000 = 36,000

Major defects 7% of R300 000 = 21,000

Total amount of defect is R57,000. Meaning to say, this is the amount of the warranty expense that needs to be recognized as a provision in the balance sheet as part of the current liabilities.

Journal entry:

(Debit) Warranty Expense R57,000

(Credit) Warranty Liability R57,000

Included is the word file that you can download and edit. Here's the link:

Step-by-step explanation

IAS 37 defines and specifies the accounting for and disclosure of provisions, contingent liabilities, and contingent assets.

Provisions

A provision is a liability of uncertain timing or amount. The liability may be a legal obligation or a constructive obligation. A constructive obligation arises from the entity's actions, through which it has indicated to others that it will accept certain responsibilities, and as a result has created an expectation that it will discharge those responsibilities. Examples of provisions may include: warranty obligations; legal or constructive obligations to clean up contaminated land or restore facilities; and obligations caused by a retailer's policy to make refunds to customers.