Question

On December 31, 2012, Lunes Company collected $174,000 in unearned subscription revenue which is to be earned equally over the next three (3) years. Pretax financial income in 2012 amounted to $595,000. Lunes’ applicable tax rate is 34% in 2012. Recently enacted tax laws have indicated that Lunes’ tax rate will increase to 37% in 2013. There is no evidence to suggest any future tax rate changes beyond what is currently known.  

Answer 1

Deferred revenue can be termed as a payment a business receives from its customers before they are actually earned, means the prepaid goods and services have not been provided yet. For the business report on cash basis this term is irrelevant. As per IRS ruling if you are reporting in accrual method, you report revenue in the tax year when it is earned, even if payment is received in an earlier year. For tax purposes, revenue is considered to be earned at the time your business has a legal right to collect payment. But there are a special rule for advance payment of services that states, When that the services will be provided in the next tax year, the revenue can only be deferred one year , which is the year that the services are provided. However, if all or part of the services would not be provided until the third year, or if you can't determine which tax year the services will be performed, the payment must be reported as income in the year it is received.

So from question we can say that the services will be provided by the Lunes company within three years so the luens cannot report the unearned earning in the year 2012 .So lunes has to deferred its unearned revenues to next tax year to report.