Question:
Apex Computer Company manufactures and sells large mainframe computers. The computers range in
price from
$1 to $3 million and gross profit averages 40% of sales price. The company has a liberal trade-in policy.
Customers are allowed to trade in their computers for a new generation machine anytime within three
years of sale.
The trade-in allowance granted will vary depending on the number of years between original sale and
trade-in.
However, in all cases, the allowance is expected to be approximately 25% higher than the prevailing
market price of the computer.
As an example, in 2013 a customer who purchased a computer in 2011 for $2 million (the computer cost
Apex
$1,200,000 to manufacture) decided to trade it in for a new computer. The sales price of the new
computer was $2.5 million and a trade-in allowance of $600,000 was granted on the old machine. As a
result of the trade-in allowance, the customer had to pay only $1.9 million ($2.5 million less $600,000)
for the new computer. The old computer taken back by Apex had a resale value of $480,000. The new
computer cost $1.5 million to manufacture.
The company accounted for the trade-in by recognizing revenue of $2,380,000 ($1.9 million received in
cash 1 $480,000 value of old computer).
Required:
Does the company’s revenue recognition policy for trade-ins seem appropriate? If not, describe the
problem created by the liberal trade-in policy.
Answer:
Apex Computer Company manufactures and sells large mainframe computers. The computers range in
price from
$1 to $3 million and gross profit averages 40% of sales price. The company has a liberal trade-in policy.
Customers are allowed to trade in their computers for a new generation machine anytime within three
years of sale.
The trade-in allowance granted will vary depending on the number of years between original sale and
trade-in.
However, in all cases, the allowance is expected to be approximately 25% higher than the prevailing
market price of the computer.
As an example, in 2013 a customer who purchased a computer in 2011 for $2 million (the computer cost
Apex
$1,200,000 to manufacture) decided to trade it in for a new computer. The sales price of the new
computer was $2.5 million and a trade-in allowance of $600,000 was granted on the old machine. As a
result of the trade-in allowance, the customer had to pay only $1.9 million ($2.5 million less $600,000)
for the new computer. The old computer taken back by Apex had a resale value of $480,000. The new
computer cost $1.5 million to manufacture.
The company accounted for the trade-in by recognizing revenue of $2,380,000 ($1.9 million received in
cash 1 $480,000 value of old computer).
Required:
Does the company’s revenue recognition policy for trade-ins seem appropriate? If not, describe the
problem created by the liberal trade-in policy.
Answer:
