DVD-Online, Inc., is in its second year of business. The company is Web-based, offering DVD rental to online customers for a fixed monthly fee. For $30 per month, a customer receives three DVDs each month, one at a time as the previous one is returned. No matter how many DVDs a customer uses (up to three), the fee is fixed at $30 per month. Customers sign a contract for a year, so DVD-Online recognizes $360 sales revenue each time a customer signs up for the service. The owner of DVD-Online, John Richards, has heard about GAAP, but he does not see any reason to follow these accounting principles. Although DVD-Online is not publicly traded, John does put the company’s financial statements on the company’s Web page for customers to see.

1. Explain how DVD-Online would account for its revenue if it did follow GAAP.

2. Explain to John Richards why he should use GAAP, and describe why his financial statements may now be misleading.

3. Do you see this as an ethical issue? Explain.