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Chapter 13: Question 10Q (page 715)

How does unearned revenue arise? Why can it be classified properly as a current liability? Give several examples of business activities that result in unearned revenues.

Short Answer

Expert verified

Unearned revenue arises when a company receives the payment for a good or service that is yet to be delivered or rendered respectively.

The company decreases the balances in the unearned revenue account and increases the balance in the revenue account, as the revenue is earned by the company. Thus, the unearned revenue account is usually classified as a current liability on the balance sheet.

Examples of unearned revenue are prepaid rent, prepaid insurance, annual subscriptions for a software license.

Step by step solution

01

Definition of Unearned Revenue

Unearned revenue occurs when cash is obtained by the company as a payment from a customer before producing goods or rendering the services as promised to the customer. However, it is regarded as a prepayment for goods and services that will be conveyed at a future date.

02

Classification of unearned revenue as a current liability

Unearned revenue is an assumption made to show the obligation made to the customer to refund the assets received in advance in case of the nonperformance of the aforesaid contract, in turn earning the rights over the assets received. However, there might be an element of unrealized profit included in the liabilities. When the unearned revenues are grouped as such, it is ignored fact that the amount of unrealized profit holds uncertain and usually not material in relation to the total obligation.

03

Examples of Unearned Revenues

  • The amount paid by the company for insurance in advance.
  • The amount paid by the company for services in advance.
  • The amount paid by the company for expenses in advance.

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Most popular questions from this chapter

(Fair Value and Equity Methods) Brooks Corp. is a medium-sized corporation specializing in quarrying stonefor building construction. The company has long dominated the market, at one time achieving a 70% market penetration. Duringprosperous years, the company鈥檚 profits, coupled with a conservative dividend policy, resulted in funds available for outside

investment. Over the years, Brooks has had a policy of investing idle cash in equity securities. In particular, Brooks has made periodicinvestments in the company鈥檚 principal supplier, Norton Industries. Although the firm currently owns 12% of the outstandingcommon stock of Norton Industries, Brooks does not have significant influence over the operations of Norton Industries.

Cheryl Thomas has recently joined Brooks as assistant controller, and her first assignment is to prepare the 2017 year-endadjusting entries for the accounts that are valued by the 鈥渇air value鈥� rule for financial reporting purposes. Thomas has gatheredthe following information about Brooks鈥� pertinent accounts.

1. Brooks has equity securities related to Delaney Motors and Patrick Electric. During 2017, Brooks purchased 100,000 shares of

Delaney Motors for \(1,400,000; these shares currently have a fair value of \)1,600,000. Brooks鈥� investment in Patrick Electrichas not been profitable; the company acquired 50,000 shares of Patrick in April 2017 at \(20 per share, a purchase that currentlyhas a value of \)720,000.

2. Prior to 2017, Brooks invested \(22,500,000 in Norton Industries and has not changed its holdings this year. This investmentin Norton Industries was valued at \)21,500,000 on December 31, 2016. Brooks鈥� 12% ownership of Norton Industries has acurrent fair value of \(22,225,000 on December 2017.

Instructions

(a) Prepare the appropriate adjusting entries for Brooks as of December 31, 2017, to reflect the application of the 鈥渇airvalue鈥� rule for the securities described above.

(b) For the securities presented above, describe how the results of the valuation adjustments made in (a) would be reflectedin the body of Brooks鈥� 2017 financial statements.

(c) Prepare the entries for the Norton investment, assuming that Brooks owns 25% of Norton鈥檚 shares. Norton reportedincome of \)500,000 in 2017 and paid cash dividends of $100,000.

On January 1, 2017, Roosevelt Company purchased 12% bonds, having a maturity value of \(500,000, for \)537,907.40.

The bonds provide the bondholders with a 10% yield. They are dated January 1, 2017, and mature January 1, 2022, with interest

received January 1 of each year. Roosevelt鈥檚 business model is to hold these bonds to collect contractual cash flows.

Instructions

(a) Prepare the journal entry at the date of the bond purchase.

(b) Prepare a bond amortization schedule.

(c) Prepare the journal entry to record the interest revenue and the amortization for 2017.

(d) Prepare the journal entry to record the interest revenue and the amortization for 2018

Under IFRS, a provision is the same as:

(a) a contingent liability (c) a contingent gain

(b) an estimated liability (d) None of the above

Where can authoritative IFRS be found related to investments?

Carow Corporation purchased, as a held-for-collection investment, \(60,000 of the 8%, 5-year bonds of Harrison, Inc.

for \)65,118, which provides a 6% return. The bonds pay interest semiannually. Prepare Carow鈥檚 journal entries for (a) the purchase

of the investment, and (b) the receipt of semiannual interest and premium amortization
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