Reference no: EM132795780

Atomby Entertainment Limited (AEL) sells multimedia presentation systems in Hong Kong. The company commenced business in 2018. Each product unit was sold for $5,000 cash representing a 25% markup over cost. The company provides a two-year parts and labor warranty on each product unit they sell. The estimated cost of providing the warranty coverage is $400 per unit. Apart from the assurance warranty, AEL also sells extended warranty services to customers. Such service warranty must be purchased at the same time as the related product is purchased, at a fee of $750 per unit. The service warranty will cover another 2 years after expiration of the assurance warranty provided by AEL.

• Approximately 70% of customers purchased the service warranty in 2018, and 80% in 2019 and 2020. Accounting year end date of AEL is December 31.
• At the end of 2020, AEL is considering changing its practice from selling service warranty separately to bundling it with the product sales. By this, customers will be automatically provided with a four-year warranty when they purchase the multimedia presentation systems. The new price of the bundled product would be the sum of the current sales prices of the product and service warranty purchased separately.

Required:

problem 1: Advise AEL on the proposed change. Explain how the accounting treatments will be different and the effects on reported income and financial statements. What are the potential negative aspects of those changes, and what other issues should be considered? Journal entries are not required.