Deferred Rental Agreement Questions

You will prepare three years of financial statements for the XXX Company, to include:

  • Two-Statement Format of Comprehensive Income; See Illustration 4-19 in the textbook
  • Balance Sheet
  • Statement of Owners’ Equity

You will do this twice, each time using a different set of accounting rules. Recall that items of Other Comprehensive Income are reported net of taxes, in the same manner as Extraordinary Items are reported; See Illustration 4-17 in the textbook for how Extraordinary Items are reported. Do not call the company XXX, but instead give it your name (e.g. Lisa Smith Company, Dalai Lama Company, Jorge Martinez Company).

Problem Data: Deferred Revenue Recognition on a Rental Agreement

On September 30 20×1, XXX Company rented to a tenant a small office space in its Dilapitated Visions Complex.

The tenant is not obligated to continue the lease beyond Summer 20×2, but pays $25,000 cash upfront towards the $1,000 monthly rent (25 months’ rent received in advance).

This is not a capital lease.

Excluding income taxes and the income effects of this rental, XXX Company has (GAAP and Tax) income of $111,111 in 20×1, $222,222 in 20×2, and $333,333 in 20×3.

The IRS requires rent to be included in taxable income in the year received 

The income tax rate is a flat 10% for all relevant years.

At January 1, 20×1, the balance sheet showed Common Stock of $444,444, Retained Earnings of $555,555, and zero Accumulated OCI.

The only change to Common Stock during these three years was an issuance of $88,888 of stock at par value in 20×2.

Report Using Current US-GAAP

Under current US-GAAP, the cash receipt is recorded as a liability (e.g. Unearned Revenue) and amortized to income at a rate of $1,000 per month. Prepare the statements, clearly labeling them as current GAAP.

Reporting Using “FASB Fantasy GAAP”

Suppose the FASB changed the appropriate accounting for the prepayment. The new rule says to recognize the cash receipt immediately in comprehensive income, and include it in Net Income only as earned (again, at $1,000 per month). Prepare the statements, clearly labeling them as FASB Fantasy GAAP.

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