You have recently been hired as the assistant controller for Stanton Temperton Corporation, which rents building space in major metropolitan areas. Customers are required to pay six months of rent in advance. At the end of 2021, the company’s president, Jim Temperton, notices that net income has fallen compared to last year. In 2020, the company reported pretax profit of $330,000, but in 2021 the pretax profit is only $280,000. This concerns Jim for two reasons. First, his year-end bonus is tied directly to pretax profits. Second, shareholders may see a decline in profitability as a weakness in the company and begin to sell their stock. With the sell-off of stock, Jim’s personal investment in the company’s stock, as well as his companyoperated retirement plan, will be in jeopardy of severe losses. After close inspection of the financial statements, Jim notices that the balance of the Deferred Revenue account is $120,000. This amount represents payments in advance from long-term customers ($80,000) and from relatively new customers ($40,000). Jim comes to you, the company’s accountant, and suggests that the company should recognize as revenue in 2021 the $80,000 received in advance from long-term customers. He offers the following explanation: “First, we have received these customers’ cash by the end of 2021, so there is no question about their ability to pay. Second, we have a long-term history of fulfilling our obligation to these customers. We have always stood by our commitments to our customers and we always will. We earned that money when we got them to sign the six-month contract.” Required: 1. Understand the reporting effect: What are the effects on pretax profits of reporting the $80,000 as service revenue? 2. Specify the options: Instead of reporting the $80,000 as revenue, how else might you report this amount? 3. Identify the impact: Are investors and creditors potentially affected by Jim’s suggestion? 4. Make a decision: As a staff employee, should you follow Jim’s suggestion?
You have recently been hired as the assistant controller for Stanton Temperton Corporation, which rents building space in major metropolitan areas. Customers are required to pay six months of rent in advance. At the end of 2021, the company’s president, Jim Temperton, notices that net income has fallen compared to last year. In 2020, the company reported pretax profit of $330,000, but in 2021 the pretax profit is only $280,000. This concerns Jim for two reasons. First, his year-end bonus is tied directly to pretax profits. Second, shareholders may see a decline in profitability as a weakness in the company and begin to sell their stock. With the sell-off of stock, Jim’s personal investment in the company’s stock, as well as his companyoperated retirement plan, will be in jeopardy of severe losses.
After close inspection of the financial statements, Jim notices that the balance of the Deferred Revenue account is $120,000. This amount represents payments in advance from long-term customers ($80,000) and from relatively new customers ($40,000). Jim comes to you, the company’s accountant, and suggests that the company should recognize as revenue in 2021 the $80,000 received in advance from long-term customers. He offers the following explanation: “First, we have received these customers’ cash by the end of 2021, so there is no question about their ability to pay. Second, we have a long-term history of fulfilling our obligation to these customers. We have always stood by our commitments to our customers and we always will. We earned that money when we got them to sign the six-month contract.”
Required:
1. Understand the reporting effect: What are the effects on pretax profits of reporting the $80,000 as service revenue?
2. Specify the options: Instead of reporting the $80,000 as revenue, how else might you report this amount?
3. Identify the impact: Are investors and creditors potentially affected by Jim’s suggestion?
4. Make a decision: As a staff employee, should you follow Jim’s suggestion?
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