FASB Code Questions (5 pts.):

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

Go to http://aaahq.org/asclogin.cfm to log in and prepare responses to the following. Provide Codification references for your responses.

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

The accounting literature that addresses the accounting for the type of separately priced warranty that Pleasant is considering is addressed by FASB ASC 605-20-25, and it explained how the revenue and costs from a separately priced extended warranty should be recognized.

Some products include warranty obligations that are incurred in connection with the sale of the product, that is, obligations that are not separately priced or sold but are included in the sale of the product. The accounting for these is described in Topic 450. Separately priced contracts for extended warranty and product maintenance contracts provide warranty protection or product services and the contract price of these contracts is not included in the original price of the product covered by the contracts.

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.

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Written Questions (10 pts):

Answer the following questions in 1 page or less for each question.

Question 1:

Pleasant Co. is considering issuing bonds for the expansion of its business overseas.Is it more advantageous for Pleasant Co. to offer customers the option to purchase additional service contracts or to provide warranties on all products sold considering its upcoming bond issuance?

Suggested approach to answer this question:

• Write out the journal entries for Assurance-typed warranties and Service-typed warranties and think of the balance sheet impact of each.
• Think about how the balance sheet impact would impact the selling price of bonds.Remember that investors look at liquidity ratios when determining the risk of a bond issuance

Question 2:

Pleasant Co. currently relies upon third-party service providers to repair products under assurance-typed warranties and is considering opening service locations.

Opening service locations would require significant fixed asset investment but would be less expensive per repair.

Discuss the impact on the balance sheet and impact on any two liquidity ratios of moving from a per unit more expensive third-party service provider to a less expensive in-house warranty servicing in an e-mail format to your hypothetical manager.

Suggested approach to answer this question:

• Consider where Pleasant Co. would gather funds for the investment in fixed assets to open service locations and its effects on the balance sheet.
• Write out the journal entries for assurance-typed warranties and think of how the estimates in the journal entries are affected by this proposed change.