Reversal of Warranty Provision

Reversal of Warranty Provision

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Hello

I need advice from experts on this forum-

Please advise the best method / accounting treatment to reverse provision for warranty.

Our company is dealing in UAV’s. We had bought few units on which the supplier provided only a year’s warranty whereas our customer was expecting 3 years warranty. We provided them 3 years warranty taking additional risks on ourselves. I had to take 100% provision for warranty because the liabilities are not covered by insurance or the manufacturer, if the UAV is in flying mode and cause any damage/loss of life- due to any reason.

This warranty period will be over in July2015. Please advise the best way to reverse the provision- in case nothing bad happens till that time.

Thanks

Vic Sam

Replies (12)

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Portia profile image
By Portia Nina Levin
25th Apr 2015 11:57

(No subject)

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By duncanedwards
30th Mar 2015 11:59

Best speak to your accountant who will be able to sort you out.

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By ireallyshouldknowthisbut
30th Mar 2015 12:09

.

@Portia, you do?  I always reverse the HTG and ensure its not FRG, or you end up getting a lowish PAI in your DLT.  What legislation are you reading?  I know you always beat me up on the legislation, but its there in black and white. s1272a.

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By paulwakefield1
30th Mar 2015 13:08

Not sure what you mean

by "100% provision for warranty" or whether that was an appropriate initial treatment but just reverse it by debiting the provision and crediting whichever account was originally debited.

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Replying to paul.benny:
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By vmn242018
31st Mar 2015 12:43

Reversal of warranty provision

Hi Paul

Example- UAV cost $100 and selling price $120 so I booked the provision equal to 100% of the cost. There was no other choice for me because supplier was not providing more than 1 year warranty and insurance company was not willing to cover the risk. Its a costly equipment and pilots are new not having much experience in flying UAV's. Moreover, I still feel that even this 100% provision was not enough because in the case of any third party liability (property or life), our company would have been made responsible. As of now the question is- can I reverse the provision in full in the same month when the 3 year warranty will expire or is there any other treatment available? 

As we are dealing in UAV's quite frequently now, please advise if there should be / can be a different way to make such provisions.

Above all, thanks for your reply given earlier.

Vic

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By paulwakefield1
31st Mar 2015 13:45

What set of Accounting standards

are you reporting under? There are so many questions posed by your answer that I think the best thing would be for you to read the relevant standard. In general, the provision should be based on expectations not worst case scenario. On the face of it the level of provision seems too much (or else you are anticipating a loss of $80 on each unit so why are you in that business?). Why should you be held responsible for pilot error; are you providing the pilots or training them? Etc., etc. etc.

In answer to your specific question; once there is no exposure to a warranty claim, the provision must be released.

Try IAS37 as a starting point.

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Replying to Sct1982:
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By vmn242018
31st Mar 2015 14:10

Reversal of warranty provision

Hi Paul

Thanks again for your reply.

We are under IFRS. 

About your questions- all are valid points but provision amount was based on one experince with the demo kit which drowned in the sea during the testing phase and this is despite the fact that the pilot (one of our own staff) was trained for 3 months. Due to his bad luck or ours, the unit malfunctioned in flying mode when the test was carried out on a ship. When the unit was sent back to the manufacturer, they confirmed that it malfunctioned due to some reasons which they tried to fix at later stages

Yes the provision levels are too high but this is natural with anything which is in flying mode (e.g. avaiation industry) because the liabilities are also unlimited and unforseen. We are in this business for many reasons- because of growth in the region and because of high margins obviously. 

We will not be held responsibile for pilot's error but during the warranty we will be held responsible if the unit malfunctions in the flying mode and cause any damage. This is especially the case when warranty from the supplier has already expired and our warranty to our client is still valid.

I will go through the standards but I believe this is a specific situation and may be I can find some reply in case studies.

Thanks a ton.

 

Vic

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By paulwakefield1
31st Mar 2015 14:36

I suggest it

might also be worth looking at published accounts for others in your sector to see what policies they adopt.

I understand your one failure example but a few points:

 

a) if it was after 3 months, this was presumably covered by your supplier's warranty

b) you are assuming a 100% failure rate in your provisioning

c) I would not have thought public liability is a warranty issue

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Replying to lionofludesch:
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By vmn242018
01st Apr 2015 14:09

Hi Paul

 

Unfortunately there are not many companies in our region dealing in high-end UAV's- we are the first one to initiate. This region is relatively new to these products and I tried to find some information during that time but no luck. There are some companies which have started dealing in these products but it is 20% of our cost price so not comparable enough.

 

Yes- the first failure was covered by the warranty but that was a good lesson because our staff had been using it for 3 months and despite this he wasnt able to land it safely during malfunction. After this incident, 2 more complaints came to our attention from our clients, to whom we had sold these units. The reason to make 100% provision equal to the cost of the unit- because I could see that even after having intense training, there was no surety that the unit can be saved upto some extent in case of a malfunction. And with that we had a risk exposure of 2 years where there was no coverage provided by the supplier. We spoke to insurance agents to provide us with third party liability insurance but they refused to do so- and we are talking about AXA and Royal Sun. It can be argued that 100% provision is too much but under which account head I would have covered potential liabilities caused by a malfunctioned flying UAV? Point to be noted that our clients (especially government clients) expected us to have the insurance as they were unable to have it covered for the same. In the case of a loss of life or severe injury, the cost of legal claims would certainly have exceeded the cost of insurance.

On a different note- its always good to have professionals, like yourself, to question one's subjective decisions. Thanks a ton

 

Rgds

Vic

 

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By paulwakefield1
01st Apr 2015 14:45

Yes but

in general one can only provide for costs arising from a past event. Hence one would provide for warranty costs for repairs to the units, on a probability basis, as a result of the sales you have made. It seems difficult to argue that there is 100% probability that all of the units sold will fail within the warranty period you have offered or else we get back to my question of why you are in business.

 

Further one would not provide for potential costs from some unspecified future event (incompetent pilots, killing a civilain, etc.) even if the liability fell upon your company (something in itself which may be questionable).

 

I don't know what regime you operate under but I suspect your taxman might not be impressed.

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By vmn242018
02nd Apr 2015 14:44

Hi Paul

I believe provisions are made based on experience with a particular event (correct me if I am wrong)- yes, the event (causing the event) must have occurred in the past but provisions are made for future based on subjective experience of the person making the provisions.

Out of all the drones, we have sold, only in 2 units we gave 2 years extended warranty because in the absence of this warranty, we wouldnt have been able to sell, whereas we got only one year standard warranty from the supplier. Important point is- warranty from the supplier start from the date of delivery of materials whereas in these 2 cases our client expected us to start the warranty from the date of training completion- which in many cases takes 3-4 months. So besides having 2 years of warranty, I was exposed to 3-4 months of additional risks. Besides these 2 cases, I have never made any provision for warranty because it was covered under back to back warranty from the supplier.

Probability of failure- probability can be ascertained after due examination of events occurred under same circumtances and frequency. In our case, I was not able to decide on the probability % because the data is not available at all. Once the unit is handed over to the client, how frequently they fly the unit and how often, it is impossible to figure out. Being a reseller, we are more at risk because client, being a government deparment can easily say that the unit was flown with utmost care while on the other side, supplier can say exactly the opposite to avoid warranty liabilities. This should be considered with the fact that we are just resellers and we did not have necessary technical expertise to judge if it was client's fault or the supplier was trying to dodge the claims.

Why are we in this business- if someone is working in a company, at the most, one can advise in one's capacity unless the person is in a decision making position. And if the person is not in a decision making position, the person should take the decision in his/her professional capacity, which is best for the company. I believe this is what I did. Funny part is- nowadays everything is dumped on "strategic thinking" so the same happened here as well. Providing 2 years warranty, despite suggesting otherwise, was our management's strategic thinking. 

May be I didnt put it correctly in my posts earlier but I have never made any provision for third party liability (property or life). This can not be done in accounting. Going back to my example- if the cost of UAV is 100 and we sold it on 120, I made a warranty provision for 100. And the main reason to make this provision in 2 cases on exceptional basis- (a) we gave 1 year additional warranty to our end client when we were not covered for the same from the supplier AND (b) in the case of any property or life damage, minimum claim from a third party would have not been less than 1000/-. In nutshell- I did not provided for 1000/- which might have occurred in the absence of no-coverage from the insurance company. I provided for the loss of the unit itself.

Based on above, I would like to know your views

 

Regards

 

Vic

 

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By paulwakefield1
02nd Apr 2015 15:32

Interesting additional information

Thank you.

 

However the wrarranty provision still assumes the total loss of both units. Now I can understand it being a total loss if the unit is lost in operation. However most aviation failures/warranty issues are identified on the ground during regular servicing or during pre flight checks. This would rarely result in the total replacement of the aircraft.

 

Operational mistakes by the pilot are of course also possible but I would expect you/the supplier to require examination of the wreckage to determine whther mechanical/electronic failure was the cause.

 

I think we could argue the toss for ages and we have probably gone as far as is possible in this forum. I still feel a provision for total replacement for those units where you are underwriting the warranty is probably excessive but you know far more about the specifics of your buisness than I. So I suggest we leave it there!

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