Reading and Interpreting Sears Holdings Corporation’s Notes—Revenue Recognition The following excerpt is taken from page 65 of the Sears Holdings Corporation (parent company of Kmart and Sears) 2006 annual report: “Revenues from the sale of service contracts are deferred and amortized over the lives of the associated contracts, while the associated service costs are expensed as incurred.”

Required 1. Assume that you buy a wide-screen television from Sears for $2,500, including a $180 service contract that will cover three years. Why does Sears recognize the revenue associated with the service contract over its life even though cash is received at the time of the sale?

2. How much revenue will Sears recognize from your purchase of the television and the service contract in Years 1, 2, and 3? (Assume a straight-line approach.) What corresponding account can you look for in the financial statements to determine the amount of service contract revenue that will be recognized in the future?