Midwest Advertising Agency handles advertising for clients under contracts that require the agency to develop advertising copy and layouts, as well as place advertisements in various media. The agency typically charges clients a commission of 15% of the media cost. The agency makes advance billings to its clients of the estimated media cost plus its 15% commission. Adjustments to these advances usually are small.
Frequently, both the billings and receipt of cash from these billings occur before the period in which the advertising actually appears in the media. A conference meeting is held between officers of the agency and the new firm of Certified Public Accountants (CPAs) recently engaged to perform annual audits. In this meeting, consideration is given to four possible points for measuring revenue:
- At the time the advanced billing is made
- When payment is received from the client
- In the month when the advertising appears in the media
- When the bill for advertising is received from the media, generally in the month following its appearance
The agency has been following the first method for the past several years, on the basis that a definite contract exists and the revenue is earned when billed. When the billing is made, an entry is prepared to record the estimated receivable and liability to the media. Estimated expenses related to the contract are also recorded. Adjusting entries are made later for any differences between the estimated and actual amounts.
As a member of the CPA firm attending this meeting, how would you react to the agency’s method of recognizing revenue? Discuss the strengths and weaknesses of each of the four methods of revenue recognition and indicate which one you would recommend the agency follow. Explain the reasons for your choice.