Problem
You have recently been appointed as a graduate accountant on the ?nancial accounting team of Wagnall & Potter Ltd which is a large retailer of adventure equipment. The ?nancial statements are being prepared and you have been assigned the preparation of the workpapers for the upcoming audit in relation to liabilities. You notice that there is a complex 3-year Provision for Warranties calculation in the prior year's workpapers with a note to say that there is no provision in the 2021 financial statements as the products are no longer sold.
However, in the information provided by the CFO, there is a set of new product lines that will be required to be recognised and disclosed to comply with AASB 13 7 Provisions, Contingent Liabilities and ContingentAssets. The components of the sales where goods have a warranty are:
1) Cost of repairs of any manufacturing defects are covered up to three years of purchase.
2) Sales of products where warranty applies totals $100,000,000 for this year.
3) Major defects are expected to cost $4,000,000 and minor defects are expected to $1,000,000
4) 75% of products have no issues within the first 12 months (year 1)
5) 15% of products have minor defects and are returned after 12 months but before 24 months (year 2)
6) 10% of products have major defects where they are returned after 24 months but prior to 36 months (year 3)
7) A risk-free discount rate is 5.5% with the probability of cash out?ows has been assessed (i.e. adjusted for risk).
Task
Calculate the Provision for Warranties to be recognised in the 2022 ?nancial statements and notes of Wagnall & Potter Ltd. Include all workings in Appendix A and include a summary of your results and findings in your report.