Question

X, a public company, is an electronic goods retailer. X’s management team is very innovative and markets its products to cater to consumer trends and preferences. As such, management’s bonus is given a bonus equal to 10% on new revenues generated each year. X’s covenant with the local bank is based on its current ratio.

At the start of the current fiscal year. X changed from selling all of its products with an optional 3^rd party extended service warranty to selling an in-house service warranty as part of the normal retail selling price of the product. Therefore, the revenue stream forms the service plan changed from being a commission from the 3rd party vendor, who took full responsibility for doing the actual repairs, to revenue being recorded as part of X’s selling price; X is now fully responsible for the actual repairs.

The new program was a tremendous success and accounts for a 5% increase in X’s annual revenues with a corresponding 5% increase in its accounts receivable. X’s management team wanted to continue recognizing the service revenue at the time the product is sold. X’s auditor objected to this accounting policy choice.  

Required:

1. Who are two users of X’s financial statements and what are their decision-making needs?
2. What is the impact on X’s assets, liabilities, revenues and/or expenses from the proposed accounting change?
3. What are TWO relevant GAAP/ financial statement concepts applicable to this situation?
4. Give 1 case fact to support the items mentioned in 2 above?
5. Give 1 case fact to dispute the items mentioned in 2 above?
6. What is your recommendation?
7. What is the impact of your recommendation to the users mentioned in 1 above?

Answer 1

Management and Bank are the two users of X's financial sttements. Management need to know about the revenue. ank ned to know about current ratio

Due to the propose accounting change, there is a 5% increase in annual revenues and 5% in account receivables