Fancy Cars sold a used car for $35,000 cash. The company will also provide 4 oil changes per year for 5 years and an extended service-type warranty for 5 years. This is the first time that Fancy has offered an extended warranty. They intend to offer it to customers on a stand-alone basis but have not yet established a sales price. The observable selling prices of the car and oil changes follow:
$$\begin{array} { | l | l | }
\hline \text { Gar } & \$ 30,000 \
\hline \text { Bil change } & \$ 50 \text { each oil change } \
\hline
\end{array}$$ a. Determine how revenue should be allocated to the various components in this transaction.
b. Apply the appropriate revenue recognition criteria to determine when revenue should be recognized for the various components of this transaction.

Question

Fancy Cars sold a used car for $35,000 cash. The company will also provide 4 oil changes per year for 5 years and an extended service-type warranty for 5 years. This is the first time that Fancy has offered an extended warranty. They intend to offer it to customers on a stand-alone basis but have not yet established a sales price. The observable selling prices of the car and oil changes follow:
 $$\begin{array} { | l | l | } 
\hline \text { Gar } & \$ 30,000 \
\hline \text { Bil change } & \$ 50 \text { each oil change } \
\hline
\end{array}$$ a. Determine how revenue should be allocated to the various components in this transaction.
b. Apply the appropriate revenue recognition criteria to determine when revenue should be recognized for the various components of this transaction.

Quizplus · Accepted Answer

The Answer is a. The residual method is appropriate since the fair value of the warranty is not determinable as a stand-alone price has not yet been established for the service-type warranty.

a. The residual method is appropriate since the fair value of the warranty is not determinable as a stand-alone price has not yet been established for the service-type warranty. b. Revenue for the car should be recognized upon delivery. Revenue for the oil changes will recorded as each of the 20 oil changes is performed (1,000/ (4/yr × 5 yrs)). The revenue for the warranty would be recognized over the 5 years.

b. Revenue for the car should be recognized upon delivery. Revenue for the oil changes will recorded as each of the 20 oil changes is performed (1,000/ (4/yr × 5 yrs)). The revenue for the warranty would be recognized over the 5 years.

Fancy Cars Sold a Used Car for $35,000 Cash Gar $30,000 Bil change $50 each oil change \begin{array} { | l | l | } \hline \text { Gar } & \$ 30,000 \\\hline \text { Bil change } & \$ 50 \text { each oil change } \\\hline\end{array} Gar Bil change ​$30,000$50 each oil change ​​

Fancy Cars Sold a Used Car for $35,000 Cash $\begin{array} { | l | l | } \hline \text { Gar } & \$ 30,000 \\\hline \text { Bil change } & \$ 50 \text { each oil change } \\\hline\end{array}$