Circuit City Case Study

Chad Dellworth

Case: Circuit City Stores, Inc.

ACCT 6350

1. Which of the three approaches to accounting for extended warranty and service contracts is most consistent with the actual substance of a sales transaction involving equipment and an extended warranty contract? Explain your selection and your reasoning fully.

Although the FASB believed that the second approach “deferral of revenue” and Michael Chalifoux, the CFO from Circuit City, believes the third approach “partial revenue recognition” to be the most consistent with this statement; I actually think the first approach “full revenue recognition” is the most accurate when dealing with an extended warranty contract. I will further illustrate my point below.

Exhibit 2 from our case reading points out that in order for full revenue recognition to occur during the sale of an extended warranty contract, “revenue must be both realized and earned prior to the recognition;” therefore, in order to determine if the revenue from Circuit City’s service contract was actually realized, I look to our class reading Recognizing Revenues and Expenses: When is Income earned? This particular reading outlined five points that must occur in order for revenue to be earned and realized.

1) The point at which an order is obtained from a customer.

2) The point at which an order is accepted and the terms of the sale are finalized.

3) The point at which goods are delivered to a customer.

4) The point at which the customer is billed.

5) The point at which payment is received from the customer.

I think it’s safe to say that all of these points were met throughout the transaction between Circuit City and their customers making an in-house purchase; therefore, revenue was fully recognized.

Exhibit 2 also points out other factors that must occur during the time of sale that help support full revenue recognition (which I have listed below):

* The customer must incur the single largest selling cost. Which...