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Query: Warranty Income Recognition

Dear Members,

I have a query regarding recognition of warranty sales.

A customer buys warranty for 3 years from a company in year 1. The Customer is entitled for only one claim during this period. The claim occurs during year 1 itself. How will the revenue be recognized?

I am of the opinion that the entire revenue should be recognized in year 1 itself because of the foll:

  1. There is only one claim permissible and hence no future claims are admissible.
  2. The amount is certain and quantifiable.
  3. The economic benefit of the transaction is assured for the company.

Members, please post your opinions.

Reply to
stringless
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On 21 Jul 2005 04:47:58 -0700, in alt.accounting " snipped-for-privacy@gmail.com" wrote in :

The standard way to recognize the revenue is to pool these prepaids each accounting period and recognize them over the life of the service contract. Even if these contracts only allow one claim (does Magnuson-Moss or other consumer protection laws allow such an exclusion?) as a whole, this recognition reflects the risk you incur.

It may be acceptable to incur the revenue as the cost is incurred, but I am curious how you plan to deal with claims that are made in the second and third year. Do you intend to recognize revenue in the first year for claims that have not been made?

Reply to
David Jensen

There are no claims in the second and third year. The customer is entitled to the claim only once during the entire 3 years. Thats why I argued it that way.

Anyway, this was a question directly lifted from CIA exam and I was curious about the treatment.

What you said about the revenue recognition was in tune with the answer they provided.

I will reproduce the question now:

An enterprise sells a durable good to a customer on January 1, 2003 and the customer is automatically given a 1-year warranty. The customer also buys an extended warranty package, extending the coverage for an additional 2 years to the end of 2005. At the time of original sale, the company expects warranty costs to be incurred evenly over the life of the warranty contracts. The customer has only one warranty claim during the 3-year period, and the claim occurs during 2004. The company will recognize the income from the sale of extended warranty ....

A. On January 1, 2003 B. In years 2004 & 2005 C.At the time of the claim in 2004 D. December 31, 2005 , when warranty expires.

Reply to
stringless

On 21 Jul 2005 20:50:54 -0700, in alt.accounting " snipped-for-privacy@gmail.com" wrote in :

Writing good questions is difficult. Understanding it differently from what the question writer intended is expected from someone taking the test.

Notice not that the customer has only one claim, but there is no contractual limit on the number of possible claims. Under the rules of question as stated, B is clearly the correct answer.

Reply to
David Jensen

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