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Revenue recognition for health club lifetime memberships

The Health Club sells lifetime memberships for $5,000 each.

These memberships entitle a person to unlimited access to the club's weight room, exercise equipment, swimming pool, and sauna.

Once a lifetime membership fee is paid, it is not refundable for any reason.

According to the provisions of SAB 101, revenue from the sale of a lifetime membership must be deferred and recognized over the average expected time that a member will continue to use the club facilities.

However, if the terms of the membership agreeemenrt are interpreted very favorably, a substantial portion of the $5,000 initial fee might be able to be recognized as revenue immediately.

King and her partners own the health club. To overcome a cash shortage, they intend to seek a new loan from their bank.

King and her partners are meeting with their accountant to provide information for preparation of financial statements.

So here are the questions:

What incentives would King and her partners have for recognizing the entire amount of the lifetime membership fee as revenue at the time it is collected?

Since the entire amount will ultimately be recognized anyway, what difference does the timiing make?

Do King and her partners have any economic incentive to go ahead and defer the membership revenue in accordance with SAB 101?

Solution Preview

What incentives would King and her partners have for recognizing the entire amount of the lifetime membership fee as revenue at the time it is collected?

1. The bank may look more favorably on the loan request because the income statement would show more profit if the lifetime memberships are all recognized as income in the current year.
2. If the Health Club wanted to sell stock in their company, the price would be higher with higher net income reported.
3. A comparative history of profits should probably show increases in both revenue and net income for ...

Solution Summary

In a 396 word solution, the concepts of revenue recognition and the timing of reporting are clearly explained.

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