Which of the following is an example of a scenario where cash is collected from a customer upfront but revenue is not recorded immediately under GAAP?

Which of the following is an example of a scenario where cash is collected from a customer upfront but revenue is not recorded immediately under GAAP?

• A. Web-based subscription software
• B. Cell phone carriers with annual prepaid service
• C. Magazine publishers that sell subscriptions
• D. A service that is performed before cash is collected

Answer: (B)

Under GAAP, cash collection doesn’t automatically mean revenue is recorded. Revenue is recognized when the company satisfies its performance obligation, not when cash is received. When cash is collected before the service or access is provided, the company records a liability called unearned (or deferred) revenue and recognizes revenue later as the obligation is fulfilled. The scenario of a cell phone carrier with annual prepaid service is the clearest example of this. The customer pays for a year of service upfront, but the carrier provides the service over the entire year. So the cash is received at the start, but revenue is earned gradually each month as the service is delivered. The company records unearned revenue at the time of payment and then reduces that liability and records revenue over the service period. Other options also involve deferring revenue over time, but the annual prepaid service is the most straightforward, textbook illustration of cash being collected upfront while revenue is recognized only as the service is actually provided. A service performed before cash is collected would recognize revenue at the time of the service, not when cash arrives.

Under GAAP, cash collection doesn’t automatically mean revenue is recorded. Revenue is recognized when the company satisfies its performance obligation, not when cash is received. When cash is collected before the service or access is provided, the company records a liability called unearned (or deferred) revenue and recognizes revenue later as the obligation is fulfilled.

The scenario of a cell phone carrier with annual prepaid service is the clearest example of this. The customer pays for a year of service upfront, but the carrier provides the service over the entire year. So the cash is received at the start, but revenue is earned gradually each month as the service is delivered. The company records unearned revenue at the time of payment and then reduces that liability and records revenue over the service period.

Other options also involve deferring revenue over time, but the annual prepaid service is the most straightforward, textbook illustration of cash being collected upfront while revenue is recognized only as the service is actually provided. A service performed before cash is collected would recognize revenue at the time of the service, not when cash arrives.