Circuit City Case

Circuit City Case

The first proposal was full revenue recognition. This method would book an entire revenue of price of product plus warranty price at the time of sale, minus cost of product and warranty cost to show profit. If costs differ from the service warranty estimate, then an adjustment would be made. On a financial statement, at the time of sale will show a high revenue number and cogs proportional to that since the warranty is included in these numbers. In future periods, the revenue amount will remain unchanged, but adjustments to cost of goods sold could be made based upon whether or not someone used their warranty to replace of fix their product.

The second method is deferral of revenue. This would book the product revenue and cost at time of sale, and book the warranty as unearned and allocate it over the lifespan of the warranty. At time of sale, revenue and costs are lower than with full revenue recognition, but there is also an account for unearned revenue with a balance in it (warranty price). In future periods, revenue will increase based upon the allocation of the warranty and congruently reduce unearned revenue. Cost may also be recorded as those are recorded when incurred.

The third method is partial revenue recognition. This method books revenue proportional to the cost of product as a percentage of total cost (product cost + warranty cost) multiplied by revenue. Cost is recorded as just the product cost, and the rest of the revenue is deferred and allocated by some basis. Additional cost is allocated when incurred. At time of sale, revenue is lower than with full revenue recognition, but higher than deferral of revenue. Cost is the same as deferral of revenue, just product cost. There is also a smaller unearned revenue account. In future periods, revenues will increase based on unearned revenue allocation, and costs may increase if warranty is used.

I think the most consistent method is partial revenue recognition. When a warranty...