Question

Renew Energy Ltd. (REL) manufactures and sells directly to customers a special long-lasting rechargeable battery for use in digital electronic equipment. Each battery sold comes with a guarantee that the company will replace free of charge any battery that is found to be defective within six months from the end of the month in which the battery was sold. On June 30, 2020, the Warranty Liability account had a balance of $45,000, but by December 31, 2020, this amount had been reduced to $5,000 by charges for batteries returned.

REL has been in business for many years and has consistently experienced an 7% return rate. However, effective October 1, 2020, because of a change in the manufacturing process, the rate increased to a total of 9%. Each battery is stamped with a date at the time of sale so that REL has developed information on the likely pattern of returns during the six-month period, starting with the month following the sale. (Assume no batteries are returned in the month of sale.)

Month Following Sale		% of Total Returns Expected in the Month
1st			20%
2nd			30%
3rd			20%
4th			10%
5th			10%
6th			10%
			100%

For example, for January sales, 20% of the returns are expected in February, 30% in March, and so on. Sales of these batteries for the second half of 2020 were:

Month		Sales Amount
July		$1,700,000
August		1,700,000
September		2,200,000
October		1,300,000
November		1,000,000
December		800,000

REL’s warranty also covers the payment of the freight cost on defective batteries returned and on new batteries sent as replacements. This freight cost is 10% of the sales price of the batteries returned. The manufacturing cost of a battery is roughly 60% of its sales price, and the salvage value of the returned batteries averages 14% of the sales price. Assume that REL follows IFRS and that it uses the expense approach to account for warranties.

Calculate the warranty expense that will be reported for the July 1 to December 31, 2020 period.

Warranty Expense

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Calculate the amount of the accrual that you would expect in the Warranty Liability account as at December 31, 2020, based on the above likely pattern of returns.

Provision in the Warranty Liability account

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Would your answer to any of the above situations change if REL followed ASPE?

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Answer 1

Calculation of expected return for respective month

Month	Sales	Expected return
July	1700000	@7% =119000
August	1700000	@7% =119000
September	2200000	@7% =154000
Octyober	1300000	@9% =117000
November	1000000	@9% =90000
December	800000	@9% =72000
Total	8700000	671000

As we know that returns start taking place from next month of sale. So, for july sale no returns in July month and hence no provision for july in july.\

Also, warranty expenses include all those expenses incurred for returning the fresh battery to the customer. BUt not profit part on that returned battery.

Calculation of warranty expense provision to be made in respective month.

Month	July	August	September	October	November	December	Total expected return till december
July	0	@20%=23800	@30%=35700	@20%=23800	@10%=11900	@10%=11900	107100
August	0	0	@20%=23800	@30%=35700	@20%=23800	@10%=11900	95200
September	0	0	0	@20%=30800	@30%=46200	@20%=30800	107800
october	0	0	0	0	@20%=23400	@30%=35100	58500
November	0	0	0	0	0	@20%=18000	18000
December	0	0	0	0	0	0	0
Total Expected sales return (A)	0	23800	59500	90300	105300	107700	386600
Freight Expense (B)@10% of A	0	2380	5950	9030	10530	10770	38660
Manufacturing Expense (C)@60% of A	0	14280	35700	54180	63180	64620	231960
less: Salvage (D)@14% of A	0	3332	8330	12642	14742	15078	54124
Net warranty Provision to be madeB+C-D	0	13328	33320	50568	58968	60312	216496

Total provision to be made till december 31st december 2019 = 216496

less: Provision already exixting = 5000

Net provision to be made = 211496