Milbank Appliance Corporation (MAC) sells major appliances (such as refrigerators, stoves, etc.) at retail. MAC sells its top- line home refrigerator, the Zero- Line, for $ 7,500. The refrigerator comes with a one- year unconditional assurance warranty on all parts and labour except for the electronic control panel, which is limited to a 90- day warranty. This warranty has an expected cost of $ 250.
For an additional $ 500 at the time of the refrigerator purchase, the warranty on the control panel can be extended to one year. This warranty can be purchased only when the refrigerator is purchased new from a MAC- licensed dealer. It is not offered as a separate item by any other company. This is an assurance warranty. As well, MAC offers a three- year extension to the basic one- year warranty, which includes annual servicing of the refrigerator. The cost is $ 1,250 if it is purchased along with the refrigerator. The extended warranty can also be purchased later (but prior to expiry of the basic warranty) for $ 1,500. he extended warranty can be purchased by owners of Zero- Line refrigerators from other dealers, provided that the customer can show dated proof of purchase (i.e.,the original sales contract).
Explain how revenue should be recognized in each of the following situations. Use the relative fair value method. Be specific, with calculations.
a. MAC sells a refrigerator with a three- year extended warranty for $ 8,000.
b. For a total price of $ 9,000, MAC sells a refrigerator together with the control panel one-year extended warranty and a three- year extended warranty.