Question

After the presentation of your report on the examination of the financial statements to the board of directors of Piper Publishing Company, one of the new directors expresses surprise that the income statement assumes that an equal proportion of the revenue is recognized with the publication of every issue of the company’s magazine. She feels that the “crucial event” in the process of earning revenue in the magazine business is the cash sale of the subscription. She says that she does not understand why most of the revenue cannot be “recognized” in the period of the cash sale.

Discuss the propriety of timing the recognition of revenue in Piper Publishing Company’s accounts with:

(a)		The cash sale of the magazine subscription.
(b)		The publication of the magazine every month.
(c)		Over time, as the magazines are published and delivered to customers.

Answer 1

Answer:

(a) The “crucial event” in determining when revenue is recognized is when a performance obligation is satisfied. In the case of subscriptions, the performance obligation is met when the magazines are delivered . The new director suggests that this principle does not apply in the magazine business and that revenue from subscription sales and advertising should be recognized in the accounts when the difficult task of selling is accomplished and not when the magazines are published and delivered to fill the subscriptions or to carry the advertising

The director’s view that there is a single crucial event in the process of earning revenue in the magazine business is questionable even though the amount of revenue is determinable when the subscription is sold. Although the firm cannot prosper without good advertising contracts and while advertising rates depend substantially on magazine sales, it also is true that readers will not renew their subscriptions unless the content of the magazine pleases them. Unless subscriptions are obtained at prices that provide for the recovery in the first subscription period of all costs of selling and filling those subscriptions, the editorial and publishing activities are as crucial as the sale in the earning of the revenue.Not until this obligation is fulfilled should the revenue associated with it be recognized in the accounts since the revenue is the result of delivering on a promise (selling and filling subscriptions) and not just the first one.Hence, only a portion not most of the revenue should be recognized in the accounts at the time the subscription is sold.

(b) Recognizing in the accounts all the revenue in equal portions with the publication of the magazine every month is subject to some of the same criticism from the standpoint of theory as the suggestion that all or most of the revenue be recognized in the accounts at the time the subscription is sold. Although the journalistic efforts of the magazine are important in the process of earning revenue, the firm could not prosper without magazine sales and the advertising that results from paid circulation. Hence, some revenue could be recognized in the accounts at the time of the subscription sale, to the extent that part of the performance obligation to the subscriber and advertisers has been met.  

This approach requires the magazine to allocate the proportion of the revenue related to advertising from that related to subscriptions. For this reason, and because the task of estimating the amount of revenue associated with the subscription sale often has been considered subjective, recognizing revenue in the accounts with the monthly publication of the magazine has received support even though it does not meet the tests of revenue recognition as well as the next alternative.

(c) Each crucial event is clearly discernible and is a time of interaction between the publisher and subscriber. A legal sale is transacted before any revenue is recognized in the accounts. Prior to the time the revenue is recognized in the accounts, it already has been received in distributable form. Finally, the total revenue is measurable with more than the usual certainty, and the revenue attributable to each crucial event is determinable using reasonable assumptions about the relationship between revenue and costs when the costs are indirect.