Outdoors R Us owns several membership-based campground resorts throughout the So

Question

Outdoors R Us owns several membership-based campground resorts throughout the Southwest. 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 multi-year 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 2000, the market value of its stock has tripled. The first sign of trouble came in 2011 when the new sales dipped sharply. One afternoon, two weeks before the end of the fiscal year, Diane Rice, CEO, and Gene Sun, controller, were having an active discussion in Sun's office. Sun: I've thought more about our discussion yesterday. Maybe something can be done about profits. Rice: I hope so. Our bonuses and stock value are riding on this period's performance. Sun: We've been recording unearned 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. Rice: What will be the effect on profits? Sun: I haven't run the numbers yet, but let's just say very favorable. Consider these questions: Why do you think liabilities had been recorded previously? Is the proposal ethical? Who would be affected if the proposal is implemented?

Explanation / Answer

Part A)

Revenues which have been received but are yet to be earned are treated as "Unearned Revenues" and are recorded as liabilities. Such a situation arises where a company has received the payment for the goods/services yet to be produced/provided. In the given case also, the company had received the payment at the time of booking the membership and was following the right approach by recording the amount so received as unearned revenue. Once the company has started providing the services to the members, it can transfer the value of services so provided from its unearned revenues account to its sales revenue.

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Part B)

No, the proposal is not ethical. As per the accounting standards, a company cannot consider advance payment received for services yet to be provided as revenue, as it has still not been earned by the company. There can be a situation where a members decides to withdraw his/her membership before the services have been provided. In such a case, the company will have to readjust its already reported sales figures which would misled investors and other stakeholders of the company. The motive behind the proposal is to improve the company's profitability and the bonuses which is not ethical. The actual financial position of the company is far different from what its managers are trying to achieve with the use of the proposed solution.

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Part C)

If the proposal is implemented, the payments will get recorded as revenues and company's sales volume would increase. This would result in an increase in the profits for the company. However, the long term impact of this proposal can be devastating as the financial information provided to different stakeholders is incorrect. As soon as these financial irregularities will get exposed, the investors would prefer to withdraw their existing investments and the company won't be able to attract any further investments. Loss of goodwill and market reputation can have a substantial affect on company's business. Additionally, the company's operations can be subject to various governance issues (for financial irregularities) by the relevant stock exchanges/government authorities.

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