Question

Revenue Recognition, Cash and Accrual Bases

Hathaway Health Club sold three-year memberships at a reduced rate during its opening promotion. It sold 1,000 three-year nonrefundable memberships for $351 each. The club expects to sell 100 additional three-year memberships for $888 each over each of the next two years. Membership fees are paid when clients sign up. The club's bookkeeper has prepared the following income statement for the first year of business and projected income statements for Years 2 and 3.

Cash-basis income statement:

	Year 1	Year 2	Year 3
Sales	$351,000	$88,800	$88,800
Equipment*	$107,000	$0	$0
Salaries and wages	49,830	49,830	49,830
Advertising	5,330	5,330	5,330
Rent and utilities	32,490	32,490	32,490
Net income (loss)	$156,350	$1,150	$1,150

*Equipment was purchased at the beginning of year 1 for $107,000 and is expected to last for three years and then to be worth $1,070.

Required:

Convert the income statements for each of the three years to the accrual basis. Indicate a net loss with a minus sign.

Hathaway Health Club
Income Statements
	Year 1	Year 2	Year 3
Sales	$	$	$
Expenses:
Depreciation	$	$	$
Salaries and wages
Advertising
Rent and utilities
Total expenses	$	$	$
Net income (loss)	$	$	$

2. Which of the following statements is incorrect?

A. Accural -Basis income statement allows the reader to focus on the long-term profit-ability of the business.

B. Accural -Basis income statement are more useful to the management.

C. Under revenue recognition, revenue is recognized when cash is received.

D. Under revenue recognition, revenue is recognized when performance obligation is satisfied.

Answer 1

a.)	Hathaway Health Club
	Income Statements			Amount $
		Year 1	Year 2	Year 3
	Sales	117,000	146,600	176,200
	Expenses:
	Depreciation	35,310	35,310	35,310
	Salaries and wages	49,830	49,830	49,830
	Advertising	5,330	5,330	5,330
	Rent and utilities	32,490	32,490	32,490
	Total expenses	122,960	122,960	122,960
	Net income (loss)	-5,960	23,640	53,240

	Working:
		Year 1	Year 2	Year 3
	Sales	117,000	146,600	176,200
		=(351000/3)	=(351000/3)+(88800/3)	=(351000/3)+((88800/3)*2)
	Depreciation	35,310	35,310	35,310
		=(107000-1070)/3	=(107000-1070)/3	=(107000-1070)/3

b.)	Under revenue recognition, revenue is recognized when cash is received because revenue is recognized when performance obligation is satisified.
	Correct answer is option C .