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Case 06 7: Crazy Computers Essay

1817 words - 8 pages

Case 06-7: Crazy Computers

Page 1

PROFESSOR’S DISCUSSION MATERIALS Objectives of the Case This case gives students an opportunity to evaluate revenue recognition issues regarding extended warranty contracts. Applicable Professional Pronouncements ASC 605-20, Revenue Recognition: Services (ASC 605-20) (FASB Technical Bulletin No. 90-1, Accounting for Separately Priced Extended Warranty and Product Maintenance Contracts (Technical Bulletin 90-1)) ASC 944, Financial Service — Insurance (ASC 944) (FASB Statement No. 113, Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts (Statement 113)) FASB Concepts Statement No. 5, Recognition and Measurement in ...view middle of the document...

Copyright 2004 © Deloitte Development LLC All Rights Reserved.

Case 06-7: Crazy Computers

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In general, ASC 605-20-25-3 (Technical Bulletin 90-1) requires that: [R]evenue from separately priced extended warranty and product maintenance contracts shall be deferred and recognized in income on a straight-line basis over the contract period except in those circumstances in which sufficient historical evidence indicates that the costs of performing services under the contract are incurred on other than a straight-line basis. In those circumstances, revenue shall be recognized over the contract period in proportion to the costs expected to be incurred in performing services under the contract. The basis for this conclusion is that revenue should be reflected as earned over the period in which the enterprise is required to provide services.

Copyright 2004 © Deloitte Development LLC All Rights Reserved.

Case 06-7: Crazy Computers

Page 3

Question If Crazy Computers Retailers (“CC”) creates a captive insurance company (“CIC”) to reinsure extended warranty contracts sold by CC, is it appropriate for CC to recognize commission revenue at the point of sale on extended warranty contracts if the third-party insurer (“TPI”) reinsures with CIC? Accounting Alternatives Alternative 1 — Yes, it is acceptable for CC to recognize commission revenue on the sale of extended warranty contracts to the end consumer at the point of sale, if TPI reinsures with CIC. Proponents of Alternative 1 believe it is appropriate for CC to recognize commission revenue on the sale of the extended warranty contract at the point of sale. Paragraph 83 of Concepts Statement 5 states that revenue is recognized when realized or realizable and earned. With respect to being “realizable,” paragraph 83(a) of Concepts Statement 5 states, in part: a. Realized or realizable. Revenues and gains generally are not recognized until realized or realizable. Revenues and gains are realized when products (goods or services), merchandise, or other assets are exchanged for cash or claims to cash. Revenues and gains are realizable when related assets received or held are readily convertible to known amounts of cash or claims to cash. [Footnote omitted]

CC has met the realizable criterion at the point of sale, because the exchange of the extended warranty for cash has taken place. However, CC must also meet the “earned” criterion. With respect to being “earned,” paragraph 83(b) of Concepts Statement 5 states, in part: b. Earned. Revenues are not recognized until earned. An entity's revenueearning activities involve delivering or producing goods, rendering services, or other activities that constitute its ongoing major or central operations, and revenues are considered to have been earned when the entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues. Gains commonly result from transactions and other events that...

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