Case #2: Circuit City Stores
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: I believe this is the most consistent with actual substance of sales transactions involving equipment and extended warranties. Circuit City matches up almost perfectly with the five criteria in Exhibit 2 in the case study. They incurred the selling costs, they have a service network in place and warranty expenses are forecasted with a great deal of accuracy. Very few customers go above the allocated cost of the service warranty, thus Circuit City does not employ a deductible. After a warranty is purchased, Circuit City’s cost and profit can be expensed with a reasonable degree of accuracy. The uncertainty is so low, it’s almost as if the warranties were like any other physical product, and can be treated as such under Approach No.1. Deferral of revenue: Two distinctly separate transactions should be accounted for separately. In this case the revenue is recognized at the time of sales while the cost associated with the warranty is accounted for separately. The contract revenue is deferred and recognized as revenue over the number of years of the warranty period. Proponents believe that it is inappropriate to recognize revenue at the point of sale because none of the services associated with the contract has been rendered and therefore the revenue had not been earned. This is fully explained in approach 2. The impact of full revenue recognition at the time of sales on the company’s financial statement will be negative. This is because the share equity on the balance sheet becomes significant. Partial Revenue Recognition: is where a company in this case circuit city store recognizes a portion of the total revenue at the time of sales with the remainder...
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