Posted: 27 Oct 2011 at 14:28 | IP Logged
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From the 2011 Wiley FAR – Module 12
Cobb Company sells appliance service contracts agreeing to repair appliances for a two-year period. Cobb's past experience is that, of the total dollars spent for repairs on service contracts, 40% is incurred evenly during the first contract year and 60% evenly during the second contract year. Receipts from service contract sales for 2 years ended Dec 31, 2011, are as follows:
2010 $500,000 2011 $600,000
Receipts from contracts are credited to unearned service contract revenue. Assume that all contract sales are made evenly during the year. What amount should Cobb report as unearned service contract revenue at Dec 31, 2011?
Wiley’s answer: $630,000
All contract sales are made evenly during the year. Therefore, the 2010 contracts range from one year expired (if sold on 12/31/10) to two years expired (if sold on 1/1/10), for an average of one and one-half years expired [(2+1/2]. Similarly, the 2011 contracts range from zero years expired to one year expired, for an average of one-half year expired [(0+1)/2]. The average unearned portion of the 2010 contracts is one-half year (two years minus one and one-half years), the last half of the second contract year. The amount of unearned revenue related to 2010 contract is computed as following:
$500,000 x 60% x ˝ = $150,000
The average unearned portion of the 2011 contracts is one and one-half years (two years minus one-half year), the last half of the first contract year and all of the second contract year. The amount of unearned revenue related to the 2011 contract is computed as follows:
2011
$600,000 x 40% x ˝ = $120,000
$600,000 x 60%=$360,000
=$480,000
Therefore, the total unearned revenue is $630,000 ($150,000+$480,000).
I’m confused by Wiley’s explanation. Someone please clarify?
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