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
a. service revenue.
b. deferred service revenue.
c. a reduction in installment accounts receivable.
d. a direct addition to retained earnings.

Answer 1

Collections received for service contracts should be recorded as deferred service revenue, which reflects the future service obligations of the company. Over time, as the service is provided, this amount will be recognized as service revenue.

Step-by-step explanation:

When Dot Point, Inc. receives collections for service contracts on appliances sold, the accounting treatment of these collections should not be recognized immediately as revenue. Since the service contracts cover a future period of time where services will be provided, the collections are a liability rather than earned revenue. Therefore, the correct way to record the collections received for service contracts is as deferred service revenue. This liability account reflects that Dot Point, Inc. has an obligation to perform services in the future, over the span of the three-year service contract. As services are rendered over time, the deferred service revenue will be recognized as service revenue on a prorated basis corresponding to the period of service delivery.