Question

Dot Point, Inc. is a retailer of washers and dryers and offers a three-year service contract on each appliance sold. Although Dot Point sells the appliances on an installment basis, all service contracts are cash sales at the time of purchase by the buyer. Collections received for service contracts should be recorded as?

1) service revenue
2) deferred service revenue
3) a reduction in installment accounts receivable
4) a direct addition to retained earnings

Answer 1

Collections for service contracts should be recorded as deferred service revenue, as the service has not yet been provided and revenue is recognized when the service is performed.

Step-by-step explanation:

Sellers often offer service contracts on large purchases like cars, appliances, and even houses. Dot Point, Inc. sells washers and dryers and provides the option to buy a service contract for a set period.

Since the service has not yet been provided at the time of contract sale, the appropriate accounting treatment for collections received for these service contracts is to record it as deferred service revenue.

This approach is aligned with the accrual basis of accounting, whereby revenue is recognized when the service is actually performed, not when the payment is received.