The Income Statement
Reality Check
Reader’s Digest records sales of magazine subscriptions as unearned revenue at the gross subscription price at the time the orders are received. Proportionate shares of the gross subscription price are recognized as revenue when the subscriptions are fulfilled.
Required
a. Assume that Reader’s Digest receives $48 from a customer for a two year subscription. Analyze this transaction in terms of the basic accounting equation.
b. Assume that the subscription is for 24 monthly issues. In terms of the basic accounting equation, what analysis would Reader’s Digest undertake when each issue is mailed?
Cendant Corporation markets memberships in discount purchasing clubs. Typical subscriptions last one year. The first month is a trial membership; members pay no fee. After the first month, members are billed monthly. However, at any time during the year long subscription period, a member can terminate the agreement and receive a refund for all amounts paid. Cendant also incurs marketing costs in attracting new members (such as mailings and phone solicitations).
Required
a. Describe two methods that Cendant could use to recognize revenue. Which method is the most conservative?
b. For each of the two revenue recognition methods described above, suggest a method of expense recognition that adheres to the matching principle.
c. Because Cendant has experienced significant accounting regularities, the SEC has forced Cendant to use certain revenue and expense methods. Which methods do you suspect these are?
Ford Motor Company reported a first quarter profit of $904 million. However, that profit included a $440 million loss from the sale of First Nationwide, a financial institution. Because Ford did not dispose of its entire financial services unit, this disposal does not qualify as a discontinued operation, but some analysts might prefer to exclude the disposal loss from Ford’s earnings when making projections about future earnings.
Required
Eliminate the First Nationwide loss from Ford’s reported net income.