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)	52 weeks ended September 2, 2007	52 weeks ended September 3, 2006	52 weeks ended August 28, 2005
Net Sales	$63,088	$58,963	$51,879
Membership fees	1,312	1,188	1,073
Total revenue	$ 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

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

	September 2, 2007	September 3, 2006
Stock options	$ 88	$ 73
Deferred income/membership fees	52	70
Excess foreign tax credits	2	4
Accrued liabilities and reserves	357	237
Other	21	24
Total deferred tax assets	520	408
Property and equipment	303	295
Merchandise inventories	109	96
Translation gain	5	2
Total deferred tax liabilities	417	393
Net deferred taxes	$ 103	$ 15

(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.

(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 2007 to compute the cash that Costco received during 2007 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 2007 for membership fees and the recognition of membership fees revenue for 2007.

	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 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.

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.