Question

The following situations relate to Bolivia Company.

1. Bolivia provides a warranty with all its products it sells. It estimates that it will sell 1,000,000 units of its product for the year ended December 31, 2017, and that its total revenue for the product will be \(100,000,000. It also estimates that 60% of the product will have no defects, 30% will have major defects, and 10% will have minor defects. The cost of a minor defect is estimated to be \)5 for each product sold, and the cost for a major defect cost is \(15. The company also estimates that the minimum amount of warranty expense will be \)2,000,000 and the maximum will be \(10,000,000.
2. Bolivia is involved in a tax dispute with the tax authorities. The most likely outcome of this dispute is that Bolivia will lose and have to pay \)400,000. The minimum it will lose is \(20,000 and the maximum is \)2,500,000.

Instructions

Prepare the journal entry to record provisions, if any, for Bolivia at December 31, 2017.

Short answer

Both sides of the journal totals $5,400,000.

Step-by-step solution

Definition of Provisions

Provision is the account maintained by the business entity in which a portion of the profit is kept aside to meet future expenses. It is also made for any reduction in the value of an asset that might take place in the future.

Journal entry to record provisions

Date	Accounts and Explanation	Debit ($)	Credit ($)
1	Warranty expenses	5,000,000
	Warranty liability		5,000,000
2	Income tax expenses	400,000
	Income tax payable		400,000
		$5,400,000	$5,400,000

Working note:

Type	% defects	Units	Cost per unit	Total cost
Minor defect	10%	100,000	$5	$500,000
Major defect	30%	300,000	$15	$4,500,000
				$5,000,000