Circuit City

In: Business and Management

Submitted By viloin
Words 382
Pages 2
PERSON: Mike Chalifoux, SVP and CFO

ISSUE: Circuit City’s Accounting Practices, specifically, revenue recognition of warranty and extended services

WHY NOW: Proposed FASB rule change

DETAILS:

The Financial Accounting Standards Board (FASB) is proposing that Circuit City use the Deferral of Revenue method of accounting for their extended warranty contracts.

Circuit City argues that this would result in a mismatch in Revenue.

This issue is important to Circuit City Stores because the accounting practices that they employ to recognize revenue will significantly alter their reported income. The contracts have much greater relative profit margins in comparison to the actual retail items.

If you compare Circuit City’s Net Sales and Operating Revenues in 1990 - 2,096,588 – and Net Earnings – 78,100 – which includes Warranty Sales, Circuit City would have to report a Net Loss if they couldn’t count the revenue made from Warranty Sales - 112,933,000.

Recognizing the $100 profit on the sale of the stereo would increase their income statement, rather than deferring and recognizing it as revenue over the two-year contract period. This will have an overall negative impact on shareholder’s equity.

DISCUSSION:

Approach 1 – Full revenue recognition

PRO | CON | * High revenue | * Least conservative * Highest risks * Doesn’t reflect the matching principle * Overstates the revenue |

Approach 2 – Deferral of revenue

PRO | CON | * Consistency | * |

Approach 3 – Partial revenue recognition * Circuit City is currently using this method because they feel comfortable with their liability

PRO | CON | * Most conservative * Company would report loses in short-term on Balance Sheet | * |

Why is this issue important to Circuit City Stores Inc.? * This issue is…...

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