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Comments (34)

Nov 1, 2017 - 12:53pm

COGS would not be the same value as revenue since one is a cost and one is a revenue number. You also have to book a decrease in inventory. You also don't offset net income (not sure why you think you would ever do this). You are recognizing a revenue number that was delayed until now so of course your NI would be higher. Essentially deferred revenue (b/s liability) was turned into a revenue (i/s credit).

Nov 1, 2017 - 1:05pm

IS: Rev +10, Taxes +4, NI+6

B/S: Current Liabilities (10), Retained Earnings +6

CFS: Cash Provided by Operating Activities (10)

I come from down in the valley, where mister when you're young, they bring you up to do like your daddy done

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Nov 1, 2017 - 2:32pm

Extra credit for mentioning DTAs

+6 (net of -4 tax when you recognize the deferred revenue of 10)

-10 since revenue is non-cash
+4 for DTA reduction (you'd already paid cash taxes on the deferred revenue. IRS uses cash accounting but GAAP uses accrual)

so 0 net change in cash

-4 DTA

-10 deferred revenue
+6 retained earnings

Aug 2, 2020 - 5:54pm

thank you very much. i am elaborating a bit to add color. to give some background, let's look at the increase in deferred revenue that presumably occurred before this decrease in deferred revenue. it's much simpler to understand when zooming out a few periods. the key thing to remind ourselves is deferred revenue creates a DTA up front, meaning when your cash (asset) goes up by 100 and deferred revenue (liability) goes up by 100, you pay the IRS 40 (cash goes down 40) and DTA (asset) goes up by 40.

your answer is spot on: once the goods are delivered, the deferred revenue liability bucket goes down and your revenue finally pays a visit to the P&L (COGS/inventory acctg applies for certain businesses too) and flows through the other two statements. notice when we recognize the revenue in the P&L (assuming C corp) we automatically apply our tax rate to get to net income (and NI flows through CF & BS). this is double-counting taxes, so we must remember to unwind the DTA when decreasing deferred revenue.

Aug 7, 2020 - 4:04pm

Also curious about this accounting puzzle. Will push you a bit further.

I agree with the above approach but here's an additional question: we'd also recognize the expenses/costs once we recognize the revenue. However, the DTA created was for taxes paid to IRS earlier on the revenue amount, not the pre-tax amount. Now that we recognize the revenue along with its costs, we have a different income tax expense number than the DTA number. The difference would be the tax rate times the cost/expenses figure.

What would you do in this situation?
Of course the balance sheet still balances. I would apply unwind the DTA to fully cover the income tax expense but then there's residual DTA left on the balance sheet that was paid to the IRS in an earlier period which we didn't use up. Does this get written down or is it carried forward as with NOL-related DTAs? Any idea?


Sep 16, 2020 - 10:02am

How do we know that cash taxes have already been paid on deferred revenue? For example, if the $10 decrease in deferred revenue accounted for recognizing revenue for month 1 of service in a new 12 month service contract, there wouldn't be a DTA yet because we would likely not have paid cash taxes to the IRS yet, correct?

So in that scenario, the Assets would be -4 due to cash being down 4, and that would balance out against the -4 balance on the L&E side. Am I missing something here?

Sep 16, 2020 - 10:24am

Thats probably too much for an interview question, but prior to your paying the taxes you'd set up the DTA, but also increase the current liability for 'income taxes payable.'

As you earned the revenue, you'd still reduce the dta because you're recognizing gaap taxes on the is, and unwinding that timing difference between gaap and tax. When you actually pay the cash taxes, you'll reduce that income taxes payable liability which shows up as a use of cash on the cfs.

Nov 2, 2017 - 6:07pm

Not accounting for DTA's, this is the way you answer this question.

10 deferred revenue decrease.

IS: Rev +10 (1-T) - NI +6
CFS: NI +6, decrease in deferred rev (use of funds) -10. Overall change - +4
BS: Assets: Cash +4. Liabilities: Decrease in def rev 10, increase in NI 6

Apr 18, 2018 - 11:29am

Thanks for the insight.

I agree with Daveo - since NI goes up by 6 and is impacted by a non-cash expense, we should adjust it in the CFS to get the net change in cash we use in the BS.

When answering this in an interview, do we want to talk about the decrease in inventory or increase in COGS that's associated with providing a good or service?

Best Response
Apr 21, 2018 - 1:45pm

Sorry for bumping this but isn't this incorrect? (Need to make sure I'm not going crazy)
I thought it was this way.

IS: Revenue +10(1-T), NI +6
CFS: NI +6 Deferred Rev -10 so overall change -4
BS: Cash -4, Liabilities -10 NI +6 and that ties -4, = -4.

Apr 21, 2018 - 4:15pm

This is the way I thought about doing it:

IS: Revenue +10(1-T), NI +6
CFS: NI +6 Deferred Rev -10 so overall change -4
BS: Cash -4, Liabilities -10 NI +6 and that ties -4, = -4

Just a question, how do you account for the decrease in inventory? Assume COGS is equal to $5, on the BS it would be -$5 Inventory, how do you balance that on the liabilities side?

Oct 10, 2018 - 11:22pm

Assuming $5 decrease in Inventory (Increase in COGS), there should be nothing impacting Liabilities.

IS: Rev -5, NI: -3

CF: NI -3, Inv. +5, ---- Change in Cash +2

BS: A [Cash +2, Inventory -5 = -3], E [Retained Earnings -3]

Oct 10, 2018 - 11:15pm

IS: Rev +10, NI +6 --- assuming 40% tax rate

CF: NI +6, Deferred Rev -10, ---- Change in Cash -4

BS: A [Cash -4], L+E [Deferred Revenue -10, Retained E +6 = -4]

Mar 12, 2019 - 4:25am

IS: Rev +10, NI +6 --- assuming 40% tax rate

CF: NI +6, Deferred Rev -10, ---- Change in Cash -4

BS: A [Cash -4], L+E [Deferred Revenue -10, Retained E +6 = -4]

why is there a decrease in liability of -10? shouldnt it 10 and then once you receive the cash you add cash and decrease the L? in this case of deferred revenue couldn't you do: A(-4 cash +10 acc.receivables), L=0 and E= 6?


Mar 12, 2019 - 2:03pm

Because Deferred Revenue is classified as a Liability.

To go deeper, deferred revenue is when a company takes payment for the product or service but has not yet delivered. It is classified as a Liability because a company using accrual accounting can only record it as revenue when money is received and the product or service is delivered. It is a liability because there is still the possibility that the product or service may not be delivered, or the buyer might cancel.

Of course, there are a lot of nooks and crannies to this under GAAP and IFRS but this is the basic premise.

Aug 2, 2020 - 5:11pm
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