If $42,000 is collected in advance on November 1 for 6-month magazine subscriptions, what amount of subscription revenue is earned by December 31?
The correct answer and explanation is :
Correct Answer:
\$14,000
Explanation:
When a company collects money in advance for services or products it has not yet delivered, this money is recorded as unearned revenue, a liability on the balance sheet. As the company delivers the product or service over time, it gradually earns the revenue and transfers it to the income statement under subscription revenue.
Let’s break down the scenario:
Step 1: Understand the time frame.
- The company received \$42,000 on November 1.
- This payment covers a 6-month magazine subscription period:
November 1 to April 30.
We want to calculate how much revenue has been earned by December 31.
Step 2: Determine the monthly revenue.
Since \$42,000 covers 6 months, divide it equally across the 6 months:
$$
\frac{\$42,000}{6 \text{ months}} = \$7,000 \text{ per month}
$$
Step 3: Count the number of months earned by December 31.
- From November 1 to December 31, there are 2 months (November and December).
- So, the revenue earned during this period is:
$$
\$7,000 \times 2 = \$14,000
$$
Step 4: Interpret the result.
- By December 31, the company has delivered 2 months’ worth of magazines.
- Therefore, \$14,000 of the \$42,000 is now considered earned revenue.
- The remaining \$28,000 is still unearned revenue (for Jan, Feb, Mar, Apr).
Accounting Impact:
- On November 1:
- Debit Cash \$42,000
- Credit Unearned Revenue \$42,000
- On December 31:
- Debit Unearned Revenue \$14,000
- Credit Subscription Revenue \$14,000
This accurately reflects the matching principle in accrual accounting—revenue is recognized when earned, not when received.