Question

Analyzing Unearned Revenue Disclosures The following disclosures are from the September 2, 2007, annual report of Costco Wholesale Corporation. Revenue Recognition: Membership fee revenue represents annual membership fees paid by substantially all of the Company's members. The Company accounts for membership fee revenue on a deferred basis, whereby revenue is recognized ratably over the one-year term of the membership period. Revenue ($ millions) Net Sales Membership fees Total revenue 52 weeks ended 52 weeks ended 52 weeks ended September 2, 2007 September 3, 2006 August 28, 2005 $63,088 $58,963 $51,879 1,312 1,188 1,073 $ 64,400 $ 60,151 $ 52,952 Current Liabilities ($ millions) September 2, 2007 September 3, 2006 Short-term borrowings $ 54 $ 41 Accounts payable 5,125 4,581 Accrued salaries and benefits 1,227 1,080 Accrued sales and other taxes 268 324 Deferred membership fees 692 584 Current potion of long-term debt 60 309 Other current liabilities 1,156 899 Total revenue $ 8,582 $ 7,818 a) Which of the following statements best explains in layman terms how Costco accounts for the cash received for its membership fees? Because Costco does not know how many of its members will continue to the end of the year, cash received from members is recorded as a liability and recognized as revenue only at year end. When it receives cash, the company records it as a current liability. Then, it recognizes revenue evenly over the year. The company records revenue when the cash is received. Because Costco has a refund policy, the company records revenue when the cash is received, less an allowance for expected membership terminations.

Answer 1

a) The statement which best explains in layman terms, how Costo accounts for the cash received for membership fees is :

"B" : When it receives cash, the company records it as a current liability. Then it recognizes revenue evenly over the year.

Reason : From 2 pieces of information given in the question, it is clearly evident that B is the answer. These are :

i) Revenue is recognized ratably over the one-year term of the membership period.

ii) We can see the "Deferred Membership fees" row in the Current Liabilities table.

b) Cash received by Costo during 2007 for the membership fees can be computed from the equation below :

Opening Deferred membership fees balance + Cash received - Membership fee revenue recognized during the year = Closing Deferred membership fee balance

584 Million $ + Cash received - 1312 Million $ = 692 Million $

Cash received = 1312 Million $ + 692 Million $ - 584 Million $

Cash received during the year for membership fees = 1,420 Million $

c)

	Balance Sheet										Income Statement
Transaction ($ million)	Cash Asset	+	Non Cash Assets	=	Liabilities	+	Contributed Capital	+	Earned Capital		Revenue	-	Expenses	=	Net Income
Cash received for membership fees	1,420		-		1,420		-		-		-		-		-
Membership fees earned	-		-		-1,312		-		1,312		1,312		-		1,312