Academic journal article Journal of Accountancy

Auto Dealers: Extended Service Contracts

Academic journal article Journal of Accountancy

Auto Dealers: Extended Service Contracts

Article excerpt

Auto dealers frequently sell their new car customers extended service contracts as add-ons to the manufacturer's warranty. For a new vehicle with a three-year warranty, the dealer might sell the buyer an additional two-year extended service contract for $800. Often, the dealership then passes off the risk of this warranty by purchasing coverage from the manufacturer or an insurer, say for a fee of $600.

The Internal Revenue Service ruled that an accrual basis car dealer must report the full customer warranty payment in income but only can deduct the amount paid by amortization over the term of the extended service contract (technical advice memorandum 921-8004).

In the example above, the IRS position would require the dealership to report $800 of income during the first year at the time of sale to the customer but to claim only the $600 as amortization deductions of $300 in the fourth year and $300 in the fifth year.

The IRS position is the dealership's purchase of the service contract coverage from either the manufacturer or an insurance company creates an asset with a useful life extending substantially beyond the tax year, therefore requiring amortization. …

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