Case #2 Circuit City Stores, Inc. (A)
1. Describe the impact the three proposed accounting methods (full revenue recognition, deferral of revenue, and partial revenue recognition) would have on the company’s financial statements: 1) at the time of the sale, and 2) in future periods.
* Full revenue recognition method would recognize total revenue and total cost at the date of sale. Adjustments will be recognized when the warranty is used in the contract period, giving by the FASB’s Statement of Financial Accounting Concept No. 5, “Recognition and Measurement in Financial Statements of Business Enterprises”. When revenue is recognized and at the end of initial financial period, full revenue recognition overstated profits in the financial statement. However, when service expense incurred, profit will be understated in the later period. In the Circuit City case, if the company recognizes total revenue of $1,100, and cost of $920, the profit of $180 will be overstated in the financial statement. If the service contract fell short the $20 estimate, the profit is understated in the later period when revenue is recognized. * Deferral of Revenue method recorded the sale of the products and the sale of the extended warranty contract as two separate transactions. It only recognizes the “revenue and cost associated with the products at the point of sale” (Bruns 2). Extended warranty contract of the products would be recognized after the period of time of the contract covered, which the profit is earned. Deferral of revenue denotes liabilities until the service is provided. At the time of the sale, the service not yet provided will increases deferred (unearned) revenue. The deferred revenue increased the liabilities of the company in the Balance Sheet. Also, deferred revenue increased the company’s net operating activities in the Statements of Cash Flows. Profit is allocated over the...