Case: RECOGNITION OF SERVICE CONTRACT REVENUES
Jackson Dunlap is president of New Miami Maintenance, Inc., which provides build- ing maintenance services. On October 15, 2008, Mr. Dunlap signed a service con- tract with Western College. Under the contract, New Miami will provide maintenance services for all Western's buildings for a period of two years, beginning on January 1, 2009, and Western will pay New Miami on a monthly basis, beginning on January 31, 2009. Although the same amount of maintenance services will be ren- dered in every month, the contract provides for higher monthly payments in the first year.
Initially, Mr. Dunlap proposed that some portion of the revenue from the con- tract should be recognized in 2008; however, his accountant, Rita McGonigle, con- vinced him that this would be inappropriate. Then Mr. Dunlap proposed that the revenue should be recognized in an amount equal to the cash collected under the contract in 2008. Again, Ms. McGonigle argued against his proposal, saying that gen- erally accepted accounting principles required recognition of an equal amount of con- tract revenue each month.
Required:
1. Give a reason that might explain Mr. Dunlap's desire to recognize contract revenue earlier rather than later.
2. Put yourself in the position of Rita McGonigle. How would you convince Mr. Dunlap that his two proposals are unacceptable and that an equal amount of revenue should be recognized every month?
3. If Ms. McGonigle's proposal is adopted, how would the contract be reflected in the balance sheets at the end of 2008 and at the end of 2009?