Question

Trueblood Company owns several membership-based campground resorts throughout the Northwest. The company sells campground sites to new members, usually during a get-acquainted visit and tour. The campgrounds offer a wider array of on-site facilities than most. New members sign a multiyear contract, pay a down payment, and make monthly installment payments. Because no credit check is made and many memberships originate on a spur-of-the-moment basis, cancellations are not uncommon.

Business has been brisk during its first three years of operations, and since going public in 2008, the market value of its stock has tripled. The first sign of trouble came in 2021 when new sales dipped sharply.

One afternoon, two weeks before the end of the fiscal year, Sally Vasquez, CEO, and Foster Smithson, controller, were having an active discussion in Sally's office.

 

Foster: I’ve thought more about our discussion yesterday. Maybe something can be done about profits.

Sally: I hope so. Our bonuses and stock value are riding on this period’s performance.

Foster: We’ve been recording deferred revenues when new members sign up. Rather than recording liabilities at the time memberships are sold, I think we can justify reporting sales revenue for all memberships sold.

Sally: What will be the effect on profits?

Foster: I haven’t run the numbers yet, but let’s just say very favorable.

Required:
1. Why do you think liabilities had been recorded previously?

2. Is the proposal ethical? Why or why not?

3. Who would be affected if the proposal is implemented? Why?

Answer 1

Advance from customers:

Advance from customer taken for services and goods to be delivered in future is recognized as unearned revenue. This unearned revenue is recognized as a liability until service and goods are delivered.

1.

Members of outdoor R Us make a refundable down payments for the contract and they can cancel the contract anytime. As per accounting rule, if the advance is received but service has not been provided, an unearned revenue liability is to be disclosed until service is delivered. That is why liabilities had been recorded previously.

2.

If the whole amount of sale is recognized as revenue, profit will increase. As the cancellation of the contract by a member can be recorded as an expense when refund is made. It is unethical to record all membership as sales at once until service is rendered.

3.

If the proposal is implemented, it will lead to misleading financial statements which impacts shareholders, stockholders, customer decision making and it might affect goodwill of company.