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Calculation of expected value

An entity sells goods with a warranty under which customers are covered for the cost of repairs of any manufacturing defects that become apparent within the first six months after purchase. If minor defects were detected in all products sold, repair costs of £1 million would result. If major defects were detected in all products sold, repair costs of £4 million would result. The entity’s past experience and future expectations indicate that, for the coming year, 75 per cent of the goods sold will have no defects, 20 per cent of the goods sold will have minor defects and 5 per cent of the goods sold will have major defects. In accordance with paragraph 24 of IAS 37 an entity assesses the probability of a transfer for the warranty obligations as a whole.

The expected value of the cost of repairs is:

(75% of nil) + (20% of £1m) + (5% of £4m) = £400,000. [IAS 37.39, Example].