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 …show more content…
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 realizes full 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 item for sale and the warranty contract” (Bruns 2), which shows not all the customers will purchase both products and warranty contracts. It was relatively low in-terms of faithful representation because it only recognizes the revenue and cost related to the product at the time of sales and records the services associated with the contract when customers were redeemed, which cause high in liability account. This will lead to decrease in stock prices, and therefore will decrease the amount investors invest in the company or reduce the number of investors. The benefit of using deferral of revenue approach is that it will lower the tax