Significant Accounting and Auditing Issues

Estimation of Warranty Provisions

Background:

 Extension of warranty term for washing machines

With increasing competition in the washing machine market, we have decided to extend the warranty term from one year to 18
months, consistent with our major competitors. The extension will be implemented as of 1 July 2X14, prospectively. This means
that for washing machines shipped on or after 1 July 2X14, the warranty term will be 18 months, while the warranty term for
washing machines shipped before 1 July 2X14 will still be one year.

Historically, almost all problems in their product occur within one year after the products are sold, and if the product does not
have a significant failure in the first year, it is almost certain to survive the following three years. Accordingly, the management
believe that almost no warranty claims will be filed between one year and 18 months from purchase; hence, there should be no
increase in the warranty provision for the six-month extension of the warranty-term since

 New product line – dishwasher

The basic method of calculating the warranty provision for this new product will probably be the same as the one we currently use
for our washing machines: (cost per claim) x (failure rate) x (most recent 3 months of shipments). We are having internal
discussions about how to quantify cost per claim and failure rate, given that we do not have adequate claim history to leverage.

Issue:
Warranty provision may be understated if the management has not appropriately considered in its estimation the effect of the
extended warranty term for our washing machines and the warranty provision for our dishwasher.

Audit Response:
Description of audit procedures:
For washing machines with 18-month warranty terms:
During the year-end audit, performed a reasonableness test of the warranty provision, as follows:

1. Obtained (from Felix Repairing) historical data on warranty claims within 18 months of the date the washing machine
was purchased by the end customer.
2. Performed an analysis with the data obtained, and recalculate the failure rate and cost per claim for washing machines
within 18 months of the end customer’s purchase date
3. Estimated the warranty provision for products with an 18-month warranty and compare the result with management’s
amount.

For dishwashers:
During the year-end audit, validated management’s assumptions regarding the failure rate of dishwashers, as follows:

1. Discussed with Felix Repairing personnel the reasonableness of the failure rate applied by management to
dishwashers.
2. Determined an average failure rate for other dishwashers on the market that share features with Crystal’s dishwashers.
3. Estimated the effect of using this average rate on the warranty provision amount.

For dishwashers:
During the year-end audit, validated management’s assumptions related to cost per claim, as follows:

1. Inquired of Felix Repairing personnel about the nature of the defects of dishwashers, and validate whether the types of
defects will vary depending on when the machine breaks down.
 2. Obtained from Felix Repairing historical data on warranty claims for dishwashers for the period from July to December
2X14.
3. Estimated the effect of differences in cost per claim (if noted) on the warranty provision amount.

Reasons for our positions:

Washing Machine
The audit team believes that it is more appropriate to use the historical claims data for washing machines sold from July 1, 2012
to June 30, 2013, with claims filed within 1.5 years after shipment date. These data is relevant since the Company’s warranty
was already extended to 1.5 years; hence, the management should be determining the amount of warranties that would probably
claimed within the period.

Dishwasher
It is more appropriate to use the average failure rate for other dishwashers on the market that shares features with the Company’s
dishwashers (industry average data).

Working Paper Reference

 PWA02 – Warranty Provision

Conclusion:

Results:
Based on the procedures performed, the audit team was able to note that the provision for warranty recorded by the Company as
of yearend is understated by MU494, 737. MU341,674 of the total warranty provisions should be presented as noncurrent
representing repair costs that are expected incurred beyond 1 year.

Management’s response:
Management agreed to book the adjustment

Unrecorded liabilities

Background:
As part of its closing process, the Company accrues various expenses at year-end. These expenses include electricity, utilities
and other transactions for which no billing statements have been received as of their closing period. These accruals are made by
the Accounts Payable (AP) Personnel and the amounts recorded are based on estimates and prior experience.

Issue:
Since these accruals are estimated based on the judgement of the AP personnel, the amounts accrued at year-end might not be
accurately recorded.
Audit Response:
Description of audit procedures:
Performed a search for unrecorded liabilities using general ledger and subledger analytics.

Using the trade payables subledger, perform the following procedures:

 Obtained an understanding of the aging profile and compare to our understanding of normal terms and prior periods.

 Considered the pattern of days lag between the entry and effective dates of entries and determine whether this appears
unusual. Respond to identified risk by designing additional procedures.

 Compared the level of invoice postings and cash payments to trade payables pre and post period end by reviewing
trending by source. Consider whether there is an indication of invoices being deferred to the subsequent period.

 Compared the total value of new invoices to the value of invoices posted to trade payables in the general ledger.

 Identified the changes in the trade payables balances. Identify invoices with a date prior to the balance sheet date or
dated after the balance sheet date that may represent costs incurred prior to the balance sheet date.

 Confirmed invoices are recorded in the correct period by verifying the original vendor invoice and other relevant
supporting documentation.

 When further evidence is required, selected a sample of new invoices for detail testing.
 When the above procedures do not provide sufficient evidence on which to conclude on the completeness of trade
payables, obtained a report of all invoices posted and cleared in the same month and select a sample to vouch to
supporting documentation.
 Analyzed vendors with open debit transactions in the subsequent period in order to determine whether these represent
payments being made for invoices not recorded at the balance sheet date.
 When data subsequent to the balance sheet date is not available, performed the procedures described using the year-
end data to perform a retrospective review to re-assess the completeness at the interim hard close date. In addition,
when required, other procedures over trade payables are provided in section

Reasons for our positions:

Working Paper Reference

 N07.1- Search for unrecorded liabilities 2X14

 N07.1- Search for unrecorded liabilities 2X14

Conclusion:

Results:

 Based on the procedures performed, the audit team was able to note that the accrued liabilities recorded by the Company
as of yearend is understated by MU12,569 and MU25,000 pertaining to electricity expenses and spare parts expense,
respectively. Please see N07.1- Search for unrecorded liabilities 2X14 and N07.1- Search for unrecorded liabilities 2X14
for further discussion

Management’s response:
Management did not agree to book the adjustment. This will be included in the SAD Template as uncorrected misstatements and
will be documented in the management representation letter.