Question

A.J. Smith Electronics is a retail consumer electronics company that also sells extended warranty contracts for many of the products that it carries. The extended warranty provides coverage for three years beyond expiration of the manufacturer’s warranty. In 2019, A.J. Smith sold extended warranties amounting to $1,700,000. The warranty coverage for all of these begins in 2020 and runs through 2022. The total expected cost of providing warranty services on these contracts is $500,000.

How should A.J. Smith recognize revenue on the extended warranty contracts? Select the most appropriate answer below.

a. A.J. Smith should recognize the extended warranty revenue in the year of sale of the electronics.

b. A.J. Smith should recognize the extended warranty revenue when the manufacturer's warranty expires.

c. A.J. Smith should recognize the extended warranty revenue proportionately during the three years of coverage.

d. A.J. Smith should recognize the extended warranty revenue in the final year of the extended warranty.

b. Estimate the revenue, expense, and gross profit reported from these contracts in the year(s) that the revenue is recognized.
Round answers to the nearest whole numbers.

Year		2020	2021	2022	Total
Revenue
Warranty expenses
Gross profit

c. In 2020, as a special promotion, A.J. Smith sold a digital camera (retail price $300), a digital photograph printer (retail price $125), and an extended warranty contract for each (total retail price $75) as a package for a special price of $399. The extended warranty covers the period from 2021 through 2023. The company sold 200 of these camera–printer packages. Compute the revenue that A.J. Smith should recognize in each year from 2020 through 2023.

	Revenue
2020
2021
2022
2023

Answer 1

(a) How should A.J. Smith recognize revenue on the extended warranty contracts?

The revenue pertaining to extended warranty contracts is to be recognized proportionately over the period of coverage.

So, the answer is,

c) A.J. Smith should recognize the extended warranty revenue proportionately during the three years of coverage.

(b) Estimation of revenue, expense and gross profit reported from these contracts in the years that the revenue is recognized:

Year 2020 2021 2022 Total Revenue $566,667 $566,667 $566,666 $ 1,700,000 Warranty expenses $ 166,667 $ 166,667 $ 166,666 $ 500,000 Gross profit $ 400,000 $400,000 $400,000 $1,200,000

(c) Computation of revenue that A.J. Smith should recognize in each year from 2020 through 2023:

Special price of the package = $399

That includes,

300 125 Digital camera $ Digital photograph printer $ Extended warranty contracts Total $ 75 500

Calculating revised price attributable to special price of the package,

Digital camera $ 239.40 300 = 399 x 500 125 = 399 x 500 Digital photograph printer $ 99.75 Extended warranty contract = 399 x 75 500 $59.85

Revenue from selling digital camera and digital photograph printer should be recognized in the year of sale i.e., 2020.

$\Rightarrow$ Revenue for 2020 = ($239.40 + $99.75) x 200 = $67,830

Revenue from extended warranty contracts should be recognized proportionately over the 3 years i.e., 2021, 2022 and 2023.

$\Rightarrow$ Revenue for each of the 3 years = ($59.85 x 200) / 3 = $3,990

Year Revenue 2020 $ 67,830 2021 $ 3,990 2022 $ 3,990 2023$ 3,990 Total $ 79,800