Circuit City Case
Sample 1
1) Which of the three approaches to accounting for extended warranty and service contracts is most consistent with the actual substance of a sales transaction involving equipment and an extended warranty contract? Explain your selection and your reasoning fully.
In our opinion, Partial Revenue Recognition approach is most consistent with the actual substance of a sales transaction involving an extended warranty contract. Using partial revenue recognition, the company can recognize partial revenue at the time of sale. We can distinguish between what is earned and what is yet to be earned. At the time of sale, the company recognized a portion of the revenue that they earned on the total sales because the warranty contract is incomplete. It recognizes the rest portion of the sale as deferred revenue and records “over the contract period” (Bruns 3). This method let the sales revenue and liabilities account to average out, which is relatively relevance and faithful representing the financial information.
* Full Revenue Recognition approach had low faithful representation. Since the revenue associated with the service of the contract has not yet been completed, which means the revenue had not been earned; therefore, it was less precise to recognize it at the sale. It will understate the liability and overstates sales revenue because this method realizesfull revenue at the point of sale and adjusts later if “actual costs under the service contract fell short” (Bruns 2). Full Revenue Recognition approach will increase the stock price because overstate of sales revenue.
* Deferral of revenue method records the product sales and extended warranty separately, it will have a higher relevance because some of the customer did not purchase warranty. According to Circuit City Stores, Inc. (A), “between 40% and 70% customers would purchase both the