Pleasant Co. manufactures specialty bike accessories. The company is known for product quality, and it has offered one of the best warranties in the industry on its higher-priced products—a lifetime guarantee, performing all the warranty work in its own shops. The warranty on these products is included in the sales price. Due to the recent introduction and growth in sales of some products targeted to the low price market, Pleasant is considering partnering with another company to do the warranty work on this line of products, if customers purchase a service contract at the time of original product purchase. Pleasant has called you to advise the company on the accounting for this new warranty arrangement. Instructions
If your school has a subscription to the FASB Codification, go to log in and prepare responses to the following. Provide Codification references for your responses. (a) Identify the accounting literature that addresses the accounting for the type of separately priced warranty that Pleasant is considering. (b) When are warranty contracts considered separately priced? (c) What are incremental direct acquisition costs and how should they be treated?
(a)FASB ASC 605-20-25 addresses how revenue and costs from a separately priced extended warranty or product maintenance contract should be recognized.
(b)An Extended Warranty is an agreement to provide warranty protection in addition to the scope of coverage of the manufacturer’s original warranty, if any, or to extend the period of coverage provided by the manufacturer’s original warranty. Product Maintenance Contracts are agreements to perform certain agreed-upon services to maintain a product for a specified period of time. The terms of the contract may take different forms, such as an agreement to periodically perform a particular service a specified number of times over a specified period of time, or an agreement to perform a particular service as the need arises over the term of the contract.
Separately Priced Contracts are agreements under which the customer has the option to purchase an extended warranty or a product maintenance contract for an expressly stated amount separate from the price of the product. FASB ASC 605-20-20-20 (Glossary)
(c)Costs that are directly related to the acquisition of a contract and that would have not been incurred but for the acquisition of that contract (incremental direct acquisition costs) shall be deferred and charged to expense in proportion to the revenue recognized. All other costs, such as costs of services performed under the contract, general and administrative expenses, advertising expenses, and costs associated with the negotiation of a contract that is not consummated, shall be charged to expense as incurred. FASB ASC 605-20-25-4