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“Compare the prior year provision with the actual level of claims in the year, to assess the reasonableness of the judgements made by management.”
professor do you mind helping me understand what the examiner is trying to hammer home with this point? specifically we compare prior year provision with actual level of claims “in the CURRENT OR PRIOR YEAR”?
B/fwd (opening) provision for product warranty claims – $3,000
Warranty claims met during the current year …. $13,000
Current y/e (closing) warranty provision per draft accounts $4,000.
What do you think? How likely that $4,000 is adequate (not materially understated)?
Just thinking up some numbers – if none provided – often helps.
professor i feel really embarrassed to ask this, but the opening $3000 is what we estimated will be our outflow in the current year, correct? and similarly $4000 is what we predict will be our outflow in the next year?
And hence the $4000 for next is a gross understatement given the warranty claims of current yr of $13000?
Yes – that is exactly it. Of course – there could be some especially large warranty claim that wasn’t expected and a “one-off” and not expected to recur – so maybe $4,000 is a reasonable estimate of the liability to be met next year – only the auditor wouldn’t just take the client’s word for that (!)
query 1: Professor instead of writing the following line:
“Compare the prior year provision with the actual level of claims in the year, to assess the reasonableness of the judgements made by management.”
if we instead write the following:
“compare the opening balance of provision (estimate for the current year) to actual claims in the current year to assess reasonableness of judgments made by management”
Do both of them end up conveying the same thing(/are interchangeable)?
query 2: I got your numerical example professor. but I am still for some reason not clear with this original sentence: “Compare the prior year provision with the actual level of claims in the year, to assess the reasonableness of the judgements made by management.”
here we are comparing prior yr provision with actual level of claims in PRIOR YR OR CURRENT YR(i suppose it will be prior yr actual claims)? Basically trying to see if management has a trend of overstating or understating the provision expense, and hence the odds that this yr too they are overstating/understating the provision ?
“Compare the prior year provision [made at the last reporting date] with the actual level of claims in [i.e. settled during] the year, to assess the reasonableness of the judgements made by management.”
You are assessing “is management any good in making accounting assessments”? If, historically, management’s judgments have been “sound” – you would expect that to continue. If management has a history of bias – to either understate or overstate provisions – you would factor that into your risk assessment and audit response.
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