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Question: CA18-6 (Recognition of Revenue from Subscriptions) Cutting Edge is a monthly magazine that has been on the market for 18 months. It currently has a circulation of 1.4 million copies. Negotiations are underway to obtain a bank loan in order to update the magazine’s facilities. Cutting Edge is producing close to capacity and expects to grow at an average of 20% per year over the next 3 years.

After reviewing the financial statements of Cutting Edge, Andy Rich, the bank loan officer, had indicated that a loan could be offered to Cutting Edge only if it could increase its current ratio and decrease its debt to equity ratio to a specified level. Jonathan Embry, the marketing manager of Cutting Edge, has devised a plan to meet these requirements. Embry indicates that an advertising campaign can be initiated to immediately increase circulation. The potential customers would be contacted after the purchase of another magazine’s mailing list. The campaign would include:

1. An offer to subscribe to Cutting Edge at three-fourths the normal price.

2. A special offer to all new subscribers to receive the most current world atlas whenever requested at a guaranteed price of $2.

3. An unconditional guarantee that any subscriber will receive a full refund if dissatisfied with the magazine.

Although the offer of a full refund is risky, Embry claims that few people will ask for a refund after receiving half of their subscription issues. Embry notes that other magazine companies have tried this sales promotion technique and experienced great success. Their average cancellation rate was 25%. On average, each company increased its initial circulation threefold and in the long run increased circulation to twice that which existed before the promotion. In addition, 60% of the new subscribers are expected to take advantage of the atlas premium. Embry feels confident that the increased subscriptions from the advertising campaign will increase the current ratio and decrease the debt to equity ratio.

You are the controller of Cutting Edge and must give your opinion of the proposed plan.

Instructions

(a) When should revenue from the new subscriptions be recognized?

Step by step solution

01

Definition of Subscription Revenue

Revenue received by the business entity by providing subscriptions for any magazine, application, or clubhouse is known as subscription revenue.

02

Recognition of revenue from the new subscription

The revenue from subscriptions must be allocated to the unearned sales revenue. After the monthly issue of the subscription, the business entity must debit the unearned sales revenue and credit sales revenue. The problem arises because of the full refund allowed to the customer. The majority of companies have refunds equal to 25% of sales. Therefore, they recognize revenue until the refund period gets expires.

Therefore, in the above case, the company will recognize revenue when:

1. The company has experience with the customer, and the refund amount can be estimated.
2. The company does not expect that revenue recognized needs to be refunded.

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