Executive Summary - Circuit City

Executive Summary

In the following report, we will provide Circuit City board with our conclusions and recommendations as per the best approach for accounting of product’s sales revenues and extended warranty revenues associated with them. As per the data given, it is obvious that the CFO is facing the challenge of either choosing the approach that would satisfy the shareholders through illustrating maximum profitability records, and on the other hand complying with the FASB’s technical bulletin to demonstrate maximum reliability of the profit figures. In all cases, it was our prime consideration that the company would maintain its competitive advantage by minimizing or smoothing out any impacts of the new accounting approach system on the company’s corporate strategy, and on the Stockholder’s Equity.

The following summarizes each approach:

Approach 1 (Full revenue recognition):

Full recognition of extended warranty revenues on sales transactions. This approach will illustrate overstated profits in the earlier financial reports when the revenues are recognized, and understated profits in the later reports when the warranty expenses are incurred, however the profit margins of the warranty contracts are high and their costs are relatively low and are highly uncertain. Their revenues contribute to about 5.4 % of the total sales which is significantly high.

Approach 2 (Deferral of revenue):

Deferral of the revenues of the warranty contracts and recognizing them over the contract period, and the direct costs of the service would be recognized as incurred. This provides a more accurate and reliable accounting system and satisfies both the ASCPA and the FASB’s technical bulletin, however the profits generated from the contracts will be distributed over the contract’s periods and therefore will reduce earnings.

Approach 3 (Partial revenue recognition):

Partial revenue recognition of the extended warranty contracts which is currently used by recognizing a portion of the total revenue on the combined transaction at the time of sale, with the remainder deferred and recognized over the contract period. This approach is supported by the SEC; however it would be a challenge to persuade the FASB to approve it. It seems ideal to consider the sales as a package but only when the conditions are met, and it can’t be generalized on all sales transactions.

In conclusion, we have found out that the approach which is the most consistent