Question

On 30 June 2019, Ollivanders Ltd., a firm specialising in magical wands, estimated warranty claims for the twelve months just finished at $10,000.  But, during the next twelve months it recorded claims for faulty wands of $30,000.  The manager assessed the product line that caused the blow out in estimated claims and concluded that the estimate for warranty claims at the end of the year on 30 June 2020 should only be $5,000.

Consider the effect of the decision and suggest reasons why the manager might make such an assessment.

Answer 1

Effect of decision-

The company had made estimation of $ 10,000,however the estimation failed and the warranty cliam of $30,000 has been recorded. It means if company is using provisional basis [ which company is using actually] then company will be making warranty expense provison of $ 25,000 [10000-30000-5000] in current year books of accounts i.e 2020.

Manager decision-

The manager has worked out the reason which lead to a claim of high amount in year 2020.There may be any problem with any production process which would have been making breakage or defects during the 2020 & manager might have worked out on the same process and corrected it with the efforts of organisational employees or outsiders, hence manager is so confident to create the provision lower than the exepected claims which is in variance with the claims of previous two year.

A practical example of it could be taken as HTC [Taiwan Co.] had introduced a smart phone with high promotion and investment in 2014-2015. where this product has problem of breakage and in the end company decided to withdraw the product from market and replaced it's existing product with other one. The product version was HTC desire 820s.In the end the company replaced all the broken smartphones with HTC desire 820G.

In The HTC scenario above case may be fit as HTC has beleive that It can't carry with such product and it also started to not to sale already produced smartphone of such version.

Hence manager might have known the reason of breakage that why he seems in too much of confident.

As a auditor you would be arguing in favor of increasing the provison for warranty claims and asking the manager for supporting evidence in favor of not to increase the provisonns.

Even then the manager does not provide with the relevent informaion related to adudit then auditor has only onw way to follow to describe this point as key audit matter as it seems lower in value.

Please comment for any additional explantion,

Thanks,