A technology company sells a complex computer program. It promises customers that it will provide updates and virus protection for three years from date of sale. The company recognizes 80% of the proceeds of selling the program as revenue, and regards the remaining 20% as an obligation to be extinguished over three years.
The company tentatively plans to report its obligation to service its product as deferred revenue on the balance sheet, recognizing one- third of the obligation as revenue each year, on grounds that this produces the best matching of costs and revenues. However, it consults you before finalizing its policy.
You point out that accounting standards are now primarily based on a measurement approach, and that matching of costs and revenues is not consistent with this approach. Instead, you recommend that the liability be measured at the amount the firm would rationally pay to be relieved of the obligation.

a. How is the 20% of proceeds allocated to the service obligation viewed under historical cost accounting? How would the obligation be viewed under a measurement approach?
b. Suggest one or more ways to determine the amount the firm would rationally pay to be relieved of the obligation.
c. Compare the relevance and reliability of your suggested approach(es) with the matching approach of writing the obligation off over three years.

  • CreatedSeptember 09, 2014
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