A. Would you support Laura in her approach to not providing for warranty costs on the 4D computers, and hence no provision at all for all products? Explain why or why not.

B. Would you support Benji in his decision to set up a provision for warranty costs on the computers? How would you justify your decision?

C. Summarise your decision on whether a provision for warranty should be recognised at period-end in Laura and Benji’s business.

Laura Williams and Benji Tan have been conducting business for a few years selling high spec gaming computers. As part of its contract of sale, the business offers a 1-year labour and parts warranty on all computers. The business has recently introduced a new product line in the form of 4D gaming computers. The 1-year warranty cover was also stated on the sales invoice for these computers.

Benji had recently read an accounting text from which he learned that it would be good accounting practice to recognise, at the end of the period, a liability for future warranty costs on sales made during the period. This was justified on the basis of the definition of ‘provisions’.

Laura was a little concerned in that, although she could recognise that an obligation for future warranty costs existed at the end of the period, she had difficulty in accepting that the future costs could be reliably measured. She pointed out that this was also a requirement of accounting standards.

Benji responded that he had examined past records and was able to determine that warranty costs which were incurred in the period following the sale averaged about 3% of net sales of computers. Laura then remarked: ‘Yes, but what about our new 4D computers? We’ve only just begun to sell these. We have no way of knowing exactly what our warranty costs will be. I think we should be consistent in our approach to handling warranty costs.’

Laura and Benji decided to approach you as an accountant for your view.