(b) Company B
(i) Provisions for manufacturing warranty claims are heavily dependent on the judgement of directors. The auditors should establish how the directors have arrived at the provision and assess it for reasonableness in the light of previous provisions and claims. More work will be required if there has been a significant discrepancy between provisions and claims in the past and more work will be required if the company does not have significant experience in dealing with this type of warranty claim.
(ii) IAS 37 ‗Provisions, Contingent Liabilities and Contingent Assets‘ states that a provision is a liability of uncertain timing or amount which should only be recognised when there is a present obligation, as a result of a past event, and where it is probable that an outflow of resources will be required to settle the obligation, the amount of which can be reliably estimated. It would appear that the warranty claim fits this description.
(iv) Auditors should check the calculation of the provision for arithmetical accuracy and to ensure that it is calculated in accordance with the method determined by directors. This can be achieved by reviewing the level of claims and payments both before and after the period-end.
(v) If there has been a change in the method of calculating the provision, the auditors should ensure that it is reasonable in the light of evidence available and that it is properly disclosed, if material. If there has been a change in the product mix to which the warranty applies, this should also be considered, particularly if there are new, relatively untried products which carry a higher risk of claims in the first few years.
(vi) If any previous provisions have been released in the current period because of over- provisions in previous periods, the auditors should ensure that the amount released is reasonable, and is properly disclosed in the income statement as appropriate. ‗Soft‘
provisions such as these can be manipulated by the client and particular care therefore needs to be taken.
(vii) A review of correspondence with customers should be performed and any legal department should be requested to provide details of disputes with customers relating to claims