According to Financial Accounting Standards Board

Background

The relevant facts of the situation are as follows:

1. Pleasant Co. is well-known for quality of bike accessories
2.  Offers life-time warranty on their high-priced products
3. Pleasant Co. performs all the warranty work
4. Pleasant Co. is considering cooperate with other company to perform the warranty work for the low-end market
5. Customers are required to pay off the service-warranty besides the original product price

Questions

1. Identify the accounting literature that addresses the accounting for the type of separately priced warranty that Pleasant is considering.
2. When are warranty contracts considered separately priced?
3. What are incremental direct acquisition costs and how should they be treated?

Analysis

Question 1. Identify the accounting literature that addresses the accounting for the type of separately priced warranty that Pleasant is considering.

According to Financial Accounting Standards Board, sellers of extended warranty or product maintenance contracts have an obligation to the buyer to perform services throughout the period of the contract and, therefore, revenue shall be recognized in income over the period in which the seller is obligated to perform. That is, revenue 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. (ASC605-20-25-2)

Question2.  When are warranty contracts considered separately priced?

A Warranty Contract is an agreement under which the customer has the option to purchase an extended warranty or product maintenance contract for an expressly stated amount separate from the price of the product. (605-20-20) In the other words, the service-type warranty offers warranty protection besides from coverage of original warranty and must be purchased individually from the product. the warranty contract for the bike accessories would be considered separately priced if the contract were not included in the sales price.

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