Apex Computer Company manufactures and sells large, mainframe computers. The computers range in price from $1 to $3 million and gross profit averages 40% of sales price. The company has a liberal trade-in policy. Customers are allowed to trade in their computers for a new generation machine anytime within three years of sale. The trade-in allowance granted will vary depending on the number of years between original sale and trade-in. However, in all cases, the allowance is expected to be approximately 25% higher than the prevailing market price of the computer.
As an example, in 2011 a customer who purchased a computer in 2009 for $2 million (the computer cost Apex $1,200,000 to manufacture) decided to trade it in for a new computer. The sales price of the new computer was $2.5 million and a trade-in allowance of $600,000 was granted on the old machine. As a result of the trade-in allowance, the customer had to pay only $1.9 million ($2.5 million less $600,000) for the new computer. The old computer taken back by Apex had a resale value of $480,000. The new computer cost $1.5 million to manufacture. The company accounted for the trade-in by recognizing revenue of $2,380,000 ($1.9 million received in cash + $480,000 value of old computer).
Does the company's revenue recognition policy for trade-ins seem appropriate? If not, describe the problem created by the liberal trade-in policy.