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How do warranty provisions affect the financial statements(FS), and how do they affect the users of the FS,

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How do warranty provisions affect the financial statements(FS), and how do they affect the users of the FS,

Am trying to figure out, how you design procedures for warranty provisions, in the sense as to what exactly are you trying to achieve or give to the users of the FS. What exactly are you trying to give them confidence over, please make the example of stating if the provisions are overstated and understated and how these statements will affect the FS and users.

October 7th 2014 AN ACCA USER 660 Points

5 Replies

+1 Vote

Warranty provision is an accounting estimate of future liability that arise because of the promise made by the company to its customers. Accounting estimate means an approximation of an amount of item in the absence of precise means of measurement. Where estimates are used in accounting management is responsible for making estimate to be reflected in financial position. These estimates are often made in conditions of uncertainty regarding the outcome of events that have occurred or are likely to occur and involve the use of judgment. As a result, the risk of material statement is greater when accounting estimates are involved and in some cases the auditor may determine that the risk of material misstatement related to an accounting estimate is a significant risk that requires special audit consideration.
For this management study past year pattern of warranty claims made by the customers, study present market trend and analyze the durability of products offered for periods under consideration. E.g. the company have offered 2 years warranty and past data suggest that for the first year the warranty claim is 5% and fro the second year it rises to 15% but because of product development in the year X1 of operation research suggest that the claims for the sales of last period drop down to 2%. Then the provision will be 10% of sales X0 and 2% of X1 sales.
Any information presented in financial statement influence the economic decision of the users of the financial statement.

For more check article
Audit of accounting estimate
https://www.frc.org.uk/Our-Work/Publications/APB/540-Audit-of-accounting-estimates.pdf

October 13th 2014 AN ACCA USER 8,730 Points
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Thanks Subash, that is very helpful, i wish everybody can be active on this facility provided by ACCA, we could achieve a lot. Please make an example of users and how an over-estimate or under-estimate will affect their decisions. From my view I think, the only time where users will be affected is when these estimates are significantly understated as profits would seem high to attract investors and maybe such an entity may be able to get loans from financial institutions, but as to how and who is affected when they are overstated. What i am trying to fully understand is the objective of my procedures behind every scenario, so as to give an assurance based on the expectations of whichever user in that scenario.
October 13th 2014 AN ACCA USER 660 Points
Edited October 13th 2014 AN ACCA USER
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Economic decision of all stakeholders (shareholders, debt holders, financial institutions, government and general public) will be affected by over/under estimate of any accounts which is material. As you state under estimate of provision will increases profit facilitating raise new debts but will also increase tax to be paid to government. Management will often try to underestimate provision when they are in position to raise new debt. However there is equal chance of over estimate of provision. Where management is concerned for drawing back its shares from the market or in takeover situation where top management is influenced by the interest of bidding company. This also decreases tax to be paid to government. Further, looking at the life cycle of product/firm overestimation is more common during initial periods of product development /firm establishment as the risk of product failure is higher.
October 14th 2014 AN ACCA USER 8,730 Points
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Thanks Subash, that is very helpful.
October 14th 2014 AN ACCA USER 660 Points
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Subash I want to let you know i made my F8 exam, thank you for your support.
February 13th 2015 AN ACCA USER 660 Points
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