Question1
The full revenue recognition ensures the matching principal is met. It establishes the accounting period where the expenses and revenues are recognized. In the case of the sale of an extended warranty, the method ensures all the cash is received at the period when extended warranty is sold. This method can be used to attract investors in the future because Circuit City Stores can manipulate this method to make their financial position better.
The deferral of revenue method could require the Circuit City Stores to change its accounting for extended warranty and product maintenance contracts. It could also delay full recognition of revenue and income until the warranty period has expired. This will affect the future of the company because the reported income would be lower than expenses. Similarly, this accounting practice would affect the future of the company because it would generate a mismatch of revenues and expenses.
Under the partial revenue recognition, the revenue from sales of extended warranty contracts is closely matched with costs. Therefore, this does not affect the future of the company because it puts the expenses under control. This method ensures the total revenue on the combined transaction is recognized at the time of sale. Similarly, the costs under the extended warranty contract would be recognized as incurred. This treatment is allowed for financial reporting in only extremely limited situations.
Question 2
The deferral of revenue method would be the appropriate approach to accounting for extended warranty and service contracts. This is so because it treat the sale of the extended warranty contracts as two unique transactions that are supposed to be recognized separately. This method will recognize only revenue and expenses related to the contract service at the time of the sale. The contract revenue would be overdue and recognized as income over the contract’s period by the use of systematic allocation approach. Similarly, the cost related to the contract service will be recognized when incurred. This method does not recognize revenue at the time of sale because it believes that services related to the contract are not yet rendered.
Since the equipment is rendered under the contract, under the deferral of revenue the revenue is not earned. This method is consistent with the actual substance of a sales transaction involving equipment and an extended warranty contract. This is so because the company can sell extended warranty contracts beyond the normal manufacturers’ warranty period. In this case, part of the extended warranty contract revenue will be recognized immediately and the rest is overdue and recognized as income in a systematic manner before the end of the contract period. Therefore, the part of deferred represents an estimate of the future costs of the contract plus a profit margin depending on the combined profit of the sale of the service and contract.
Question 3
If the FASB requires Circuit city stores to change the accounting for extended warranty contracts and product maintenance contracts, this will affects its financial statements. This is so because it would delay full recognition of revenue and income until the warranty period is expired. This affects three financial statements of the Circuit city stores because journal entries must be made at the end of each accounting period in order to ascertain the appropriate matching of revenues and expenses.
The financial statements will be affected because the profit margin on the extended warranty contract will usually change compared to the profit margin on the product. However, any adjustment made during the recognition of the revenue cannot have the same effect on the three financial statements. This is so because change of the revenue and expenses will not affect both balance sheet and income statement or cash flow in the same way. Therefore, the change of accounting practices can negate the effect on income and the expense, which will have effect on the three financial statements.
Question 4
Getting the best accounting practice is extremely vital for the Circuit city stores. This is so because getting the effective accounting practice will help the company to determine how efficiently it has discharged its responsibilities towards the good corporate governance. Therefore, it will help Circuit city stores to improve its accounting practices to achieve good corporate governance. The company will also enhance the comparability dimensions of financial statement and reporting. It is also an important issue because it will help Circuit city stores to employ the best accounting practices, which is appropriate measure to all firms. This helps the company to realize the appropriate revenue that can be used to attract investors because the best accounting practice help the company to recognize its financial performance. This is so because it ensures that the recognized revenue is correct and reflect the financial position of the company. This is an important issue because using proper accounting practice will ensure the company is free of any material misstatement because it will reflect the real picture of its financial performance. Therefore, the accounting practices are extremely vital for the Circuit city stores.
