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Analyzing Unearned Revenue Disclosures The following disclosures are from the August 29, 2010, annual report of Costco Wholesale Corporation. Revenue Recognition: We generally recognize sales,

Analyzing Unearned Revenue Disclosures The following disclosures are from the August 29, 2010, annual report of Costco Wholesale Corporation. Revenue Recognition: We generally recognize sales, net of estimated returns, at the time the member takes possession of merchandise or receives services. When we collect payment from customers prior to the transfer of ownership of merchandise or the performance of services, the amount received is generally recorded as deferred revenue on the consolidated balance sheets until the sale or service is completed. Membership fee revenue represents annual membership fees paid by our members. We account for membership fee revenue, net of estimated refunds, on a deferred basis, whereby revenue is recognized ratably over the one-year membership period.

Revenue ($ millions) 52 weeks ended August 29, 2010 52 weeks ended August 30, 2009 52 weeks ended August 31, 2008
Net Sales $76,255 $69,889 $70,977
Membership fees 1,691 1,533 1,506
Total revenue $ 77,946 $ 71,422 $ 72,483

Current Liabilities ($ millions) August 29, 2010 August 30, 2009
Short-term borrowings $ 26 $ 16
Accounts payable 5,947 5,450
Accrued salaries and benefits 1,571 1,418
Accrued sales and other taxes 322 302
Deferred membership fees 869 824
Current potion of long-term debt -- 80
Other current liabilities 1,328 1,191
Total revenue $ 10,063 $ 9,281

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

August 29, 2010 August 30, 2009
Equity compensation $ 112 $ 117
Deferred income/membership fees 118 94
Accrued liabilities and reserves 392 408
Other 35 48
Total deferred tax assets 657 667
Property and equipment 414 403
Merchandise inventories 170 184
Total deferred tax liabilities 584 587
Net deferred taxes $ 73 $ 80

(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.

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

Because Costco has a refund policy, the company records revenue when the cash is received, less an allowance for expected membership terminations.

(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 2010 to compute the cash that Costco received during 2010 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 2010 for membership fees and the recognition of membership fees revenue for 2010.

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 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 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 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.

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