Zac Murphy is president of Blooming Colors Inc., which provides landscaping services in Tallahassee, Florida. On November 20, 2011, Mr. Murphy signed a service contract with Eastern State University. Under the contract, Blooming Colors will provide landscaping services for all of Eastern’s buildings for a period of two years, beginning on January 1, 2012, and Eastern will pay Blooming Colors on a monthly basis, beginning on January 31, 2012. Although the same amount of landscaping services will be rendered in every month, the contract provides for higher monthly payments in the first year.
Initially, Mr. Murphy proposed that the revenue from the contract should be recognized in 2011; however, his accountant, Sue Storm, convinced him that this would be inappropriate. Then Mr. Murphy proposed that the revenue should be recognized in an amount equal to the cash collected under the contract in 2011. Again, Ms. Storm argued against his proposal, saying that generally accepted accounting principles (GAAP) required recognition of an equal amount of contract revenue each month.
1. Give a reason that might explain Mr. Murphy’s desire to recognize contract revenue earlier rather than later.
2. Put yourself in the position of Sue Storm. How would you convince Mr. Murphy that his two proposals are unacceptable and that an equal amount of revenue should be recognized every month?
3. If Ms. Storm’s proposal is adopted, how would the contract be reflected in the balance sheets at the end of 2011 and at the end of 2012?