Analyzing Unearned Revenue Disclosures The following disclosures are from the August 31, 2008, 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)	52 weeks ended August 31, 2008	52 weeks ended September 2, 2007	52 weeks ended September 3, 2006
Net Sales	$70,977	$63,088	$58,963
Membership fees	1,506	1,312	1,188
Total revenue	$ 72,483	$ 64,400	$ 60,151

Current Liabilities ($ millions)	August 31, 2008	September 2, 2007
Short-term borrowings	$ 134	$ 54
Accounts payable	5,225	5,125
Accrued salaries and benefits	1,321	1,227
Accrued sales and other taxes	283	268
Deferred membership fees	748	692
Current potion of long-term debt	6	60
Other current liabilities	1,157	1,156
Total revenue	$ 8,874	$ 8,582

The components of the deferred tax assets and liabilities are as follows (in $ millions):

	August 31, 2008	September 2, 2007
Stock options	$ 98	$ 88
Deferred income/membership fees	62	52
Exceed foreign tax credits	4	2
Accrued liabilities and reserves	431	357
Other	59	21
Total deferred tax assets	654	520
Property and equipment	351	303
Merchandise inventories	146	109
Translation gain	5	5
Total deferred tax liabilities	502	417
Net deferred taxes	$ 152	$ 103

(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.

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.

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

(b) Use the balance sheet information on Costco's Deferred Membership Fees liability account and its income statement revenues related to Membership Fees earned during 2008 to compute the cash that Costco received during 2008 for membership fees. Total cash received (in $ millions) = $Answer (c) Use the financial statement effects template to show the effect of the cash Costco received during 2008 for membership fees and the recognition of membership fees revenue for 2008.

	Balance Sheet
Transaction	Cash Asset	+	Noncash Assets	=	Liabilities	+	Contributed Capital	+	Earned Capital
Cash received for membership fees	Answer		Answer		Answer		Answer		Answer
Membership fees earned	Answer		Answer		Answer		Answer		Answer

Income Statement
Revenue	-	Expenses	=	Net Income
Answer		Answer		Answer
Answer		Answer		Answer

(d) Costco reports a deferred tax asset related to deferred income/membership fees. Explain in layman terms how this asset arises. When will Costco receive the benefit associated with this asset?

For financial reporting purposes, Costco recognizes revenue from membership fees on an accrual basis. The deferred tax asset implies that the company pays tax in cash before it reports the tax expense. This means that Costco must report GAAP revenue more slowly (in later periods) than for tax purposes. From this we can infer that the tax authorities use a cash basis for taxing membership fees.

For financial reporting purposes, Costco recognizes revenue from membership fees on an accrual basis. The deferred tax asset implies that the company pays tax in cash after it reports the tax expense. This means that Costco must report GAAP revenue more quickly (in earlier periods) than for tax purposes. From this we can infer that the tax authorities use a cash basis for taxing membership fees.

For tax purposes, Costco recognizes revenue from membership fees on an accrual basis. The deferred tax asset implies that the company pays tax in cash before it reports the tax expense. This means that Costco must report GAAP revenue more slowly (in later periods) than for tax purposes. From this we can infer that Costco recognizes revenue from membership fees on a cash basis for book purposes.

For tax purposes, Costco recognizes revenue from membership fees on an accrual basis. The deferred tax asset implies that the company pays tax in cash after it reports the tax expense. This means that Costco must report GAAP revenue more quickly (in later periods) than for tax purposes. From this we can infer that Costco recognizes revenue from membership fees on a cash basis for book purposes.