Essay About Service Term And Sale Of Service Contracts

Accounting for Extended Warranty ContractsExampleStereoContractTotalRevenue10001001100Cost90020920Profit10080180MethodsFull revenue recognition: Recognize full revenue and cost on the date of sale. Hence full profit of $180 will be recognized. If during the service term of 2 years, the service cost exceeds or falls short of $20, adjustment will be made on a later date.Deferred Revenue Recognition: Sale of stereo and sale of service contracts are two separate heads. Though the service contract has been sold today but the services associated with the contract have not been rendered hence should be deferred and recognized over 2-year period using some systematic allocation method.Partial Revenue Recognition: A part of the combined transaction will be recognized at the time of sale, with the remainder deferred and recognized over the contract period. The cost associated with the extended warranty will be recognized as incurred. Q1. Partial revenue Recognition.       Reason:All 4 points mentioned in the case 54% of customers buy warranty. Extended warranty relates to the product sold by circuit cityProfit margin is 400% which is unusually high Cost estimate to a high degree of reliability            Partial recognition also allows provisioning for estimated cost of servicing which is deferred and hence lowers the risk of inflated cost if any.Q4. Mike Chalifax should shift to deferral method, make an Q3. The effects on the financial statement of city circuit may be as followsThe income derived from sale for warranty is a major part of net income and if taken out will have drastic effect on the eps. A lower EPS might disappoint the shareholders.Profitability Measures will take a HitRoe will go down Test on investment utilization (Asset turnover, equity turnover, etc) will go downQ2. Importance to circuit cityIncome will go down which might have a negative impact on the shareholdersThere was a huge profit margin in selling the warranty and if they had to do the third party reselling, it might shrink the margin on profit.