Hey All,
New to this forum, looking to take FAR in late May depending on how my studying goes for the next month. I just signed up for Becker but considering switching to something else. I came across a question for their adjusting journal entries section I was hoping someone here might be able to give me some insight on because the logic behind the explanation continues to elude me. The question reads as:
Dunne Co. sells equipment service contracts that cover a two-year period. The sales price of each contract is $600. Dunne's past experience is that, of the total dollars spent for repairs for service contracts, 40% is incurred evenly during the first year and 60% evenly during the second contract year. Dunne sold 1,000 contracts during the current year. In its December 31 balance sheet, what amount should Dunne report as deferred service contract revenue?
540,000
480,000
300,000
360,000
So the answer is 480,000 according to becker because: “Since repairs are made evenly (July 1 is average date), only 1/2 repairs will be in the current year.” 600,000 * .4 = 240,000 * 1/2 = 120,000 recognized current year, 480,000 deferred.
What I just can't seem to grasp is how and why the question is applying the term evenly the way it is, based on the information in the question. Since, repairs are made evenly and thus revenue recognized evenly, and contracts sold evenly, wouldn't a more appropriate calculation be:
1000/12 = 83.3 contracts per year
40% of 600 = 240
240/12 = 20 per month
83 contracts sold in January * 240 = 19,920 rev recognized
83 sold in Feb * 220 ($20 * 11 months rev rec) = 18,260
etc etc
which result in about 129,000 rev recognized in the current year
OR
if we weight the sales dollars sold by month:
600,000 contract revenue in current year/ 12 months = 50,000 contract sales per month
Jan: 50,000 * .4 *12/12 = 20,000
Feb: 50,000 * .4 * 11/12 = 18,333
etc etc
Which would result in 130,000 revenue recognized in the current year
I reached out to Becker academic support and over the course of multiple responses they simply could not do anything but regurgitate the default answer to divide by 2. Can anyone shed some light on how the term evenly, based specifically on the fact pattern in this question, mean to average out the first year sales by 2? Can someone tell me where my logic is going wrong? I even googled this question and it looks like they've been reusing this question since 1992, but no luck in understanding it any better.
.