Question

Assume that on September 1, 2013, Costco collected $7,200 in membership fees from customers for service in the next 12 months. How would Costco record this transaction on September 1, 2013?

Select one:

a. increase Cash by $7,200 and decrease Accounts Receivable by $7,200

b. increase Cash by $7,200 and decrease Inventory by $7,200

c. increase Cash by $7,200 and increase Unearned Revenue by $7,200

d. increase Cash by $7,200 and increase Revenue by $7,200, increase Net Income by $7,200, and increase Retained Earnings by $7,200.

e. increase Cash by $7,200 and decrease Inventory by $7,200

The annual report of Costco Wholesale Corporation for fiscal year ended September 1, 2013, includes the following footnote (excerpted):

Revenue Recognition

The Company generally recognizes sales, which include shipping fees where applicable, net of estimated returns, at the time the member takes possession of merchandise or receives services. When the Company collects payments from customers prior to the transfer of ownership of merchandise or the performance of services, the amounts received are generally recorded as deferred sales, included in other current liabilities on the consolidated balance sheets, until the sale or service is completed. The Company reserves for estimated sales returns based on historical trends in merchandise returns, net of the estimated net realizable value of merchandise inventories to be returned and any estimated disposition costs. Amounts collected from members, which under common trade practices are referred to as sales taxes, are recorded on a net basis.

The Company evaluates whether it is appropriate to record the gross amount of merchandise sales and related costs or the net amount earned as commissions. Generally, when Costco is the primary obligor, is subject to inventory risk, has latitude in establishing prices and selecting suppliers, can influence product or service specifications, or has several but not all of these indicators, revenue and related shipping fees are recorded on a gross basis. If the Company is not the primary obligor and does not possess other indicators of gross reporting as noted above, it records the net amounts as commissions earned, which is reflected in net sales.

The Company accounts for membership fee revenue, net of estimated refunds, on a deferred basis, whereby revenue is recognized ratably over the one-year membership period. The Company’s Executive Members qualify for a 2% reward (up to a maximum of $750 per year on qualified purchases), which can be redeemed at Costco warehouses. The Company accounts for this reward as a reduction in sales. The sales reduction and corresponding liability (classified as accrued member rewards on the consolidated balance sheets) are computed after giving effect to the estimated impact of non-redemptions based on historical data. The net reduction in sales was $970, $900, and $790 in 2013, 2012, and 2011, respectively.

Answer 1

Correct answer is Option (C) Increase Cash by $7,200 and increase Unearned Revenue by $7,200

Explanation;

As per information of the question, it is clear that Costo collected $7200 from customers hence cash will be increased by $7200. As customer services to be performed in next 12 month hence it will result into an increase in Unearned revenue because it can not be treated as revenue untill actual services are performed.

Hence correct answer is option (C).