Question

Niwot Co. sells products and service plans both separately and bundled together. Willy Loman, a Niwot Co. salesman, sold a Widgetron in year 5 for $1,000, its normal price, and told the customer he’d "throw in the 3-year service plan for free," which the company normally sells for an additional $150. The product shipped, the customer paid, and $1,000 in revenue was recognized in year 5. Is this correct? Why or why not?

Answer 1

Available options are:

A. This is correct because the understanding between the seller and customer was that the product price was $1,000 and the service plan was free, which is in accordance with the principle of faithful representation.

B. This is incorrect because services must be rendered before any revenue can be recognized.

C. This is correct because the product shipped and the customer paid.

D. This is incorrect because the services are not truly free and service revenue must be allocated over the three years of the service plan.

Answer:

Option D. This is incorrect because the services are not truly free and service revenue must be allocated over the three years of the service plan.

Step-by-step explanation:

The company was promoting its product by offering the 3 years services free of cost which means that the existing product was actually sold at discount equivalent to amount of 3 year services which the company sells at $150. So the sale of product recognized in the year must be at $850 and the sales of services must be at $50 ($150 / 3 Years).

However, the company recognized the whole of the amount received which is an incorrect treatment because the services sold are not free.

Hence the option D is correct.