Okay welcome back, audit learners. We ended the last lesson by looking at accounts receivable, and I want to set up an exercise where you, if you play along, we'll think about this one a little bit on your own before I go through the solution, which is in the next lesson. What I want to look at is a coffee company, Caribou, still around but no longer public company. And we're going to look at something called deferred revenue. This is if you were to have an iPhone or Android phone, you can get a Caribou app, just like you can get Starbucks app, and you can get your card. One thing you do when I say card, you can have a store specific card, and when you buy coffee, you don't have to wait until you buy the coffee to give this company money, is one of the beautiful things that these companies have draft up and I confess that I use it a lot for Starbucks. So, I carry around on my iPhone, a Starbucks card, this old physical card, so you have an electronic card now, where I'm always loading more money on that app and from Starbucks perspective, that is not yet revenue. That is deferred revenue. In some sense that's, in an accounting sense, it's every bit a liability. So, revenue is something where the earnings process is complete, right? Well where deferred revenue, that's telling you that the company still has an obligation to perform. It is the case, is kind of a trick question if you want to think about it, are there cases where companies like to grow their deferred revenue as fast or faster than the revenue? And the answer is yes, sometimes that's true, that they do want to grow some liabilities really fast, these deferred revenues, that's telling you that there's more and more customer loyalty. But when you have deferred revenue, because customers like myself are loading dollar onto Caribou cards before they go and purchase a muffin or a latte or a iced tea. There's an accounting for that that needs to be carefully attendant to. Deferred revenue shows up in the balance sheet, as do all liabilities, but one thing you look at in a revenue, deferred revenue case is a complex footnote. Take a look at this footnote and I'll let you... I'll tell...I'll read along and you can stop the tape and just read it yourself if you prefer. The company sells stored value cards of various denominations. Cash receipts related to stored value card sales are deferred when initially received and revenue is recognized when the card is redeemed and the related products delivered to the customer. Such amounts are classified as a current liability on the company's consolidated balance sheet. The company will honor all store value cards presented for payment. However, the company does look at the likelihood of redemption and when it's remote for certain card balances due to long periods of inactivity, that's called breakage. At that point the company estimates the cards which have had no activity for 48 months, which are unlikely to be used in the future in these circumstances. To the extent that management determines that there is no requirement for remitting balances to government agencies under unclean property laws, card balances may be recognized as revenue. So, not all unredeemed cards is going to be deferred revenue. Some unredeemed cards, ultimately thought to be never going to be used in the future can be classified as revenue. So you see, it's a pretty complex transaction, pretty complex event. So what I want you to do is to think about this footnote for just a second and all of the audit implications, for deferred revenue in particular and thinking about if it's not in deferred revenue, where should this be recorded? It should be recorded, the choice comes down often to revenue and deferred revenue. So keep in mind here's what happens, cash is received right when the gift card or the stored value card balance is increased, the debit is going to be to cash, the credit is going to be to what? Deferred revenue. Then how much of that deferred revenue, that liability, is translated into revenue depends on when customers redeem the card, when they go into Caribou, when they go into Starbucks and purchase the product. That's the main facet of this exercise. A little bit more complex twist on this exercise is what about those customers who give these gift cards, and you see these often on holidays, even though we're very much into the store value card in the electronic space, you see physical gift cards given at holidays, birthdays all the time. Christmas for example, and they're inevitably lost. That's a great gig for companies, because they are selling a card and they're not having to give any inventory up for those. What a win for these companies. Sell a card, give it as a gift, it gets lost, and the gross margin on that is 100%. So, take a look at this footnote, think about audit implications, and I'll see you on the next lesson.
