Question

Nate Beggs signs a 1-year contract with BlueBox Video. The terms of the contract are that Nate is required to pay a nonrefundable initiation fee of \(100. No annual membership fee is charged in the first year. After the first year, membership can be renewed by paying an annual membership fee of \)5 per month. BlueBox determines that its customers, on average, renew their annual membership three times after the first year before terminating their membership. What amount of revenue should BlueBox recognize in its first year?

Short answer

BlueBox should recognize revenue of $70 in its first year.

Step-by-step solution

Meaning of Revenue Recognition

Revenue recognition is an accounting concept. Revenue is recognized when goods are exchanged for amonetary value (amount) or when services are performed and a monetary value (cash) is received in return, according to the revenue recognition principle.

Amount of revenue recognized by BlueBox in its first year

Customers pay $5 per month as membership fee which means,

$\begin{array}{rcl}\mathrm{Membership}\mathrm{fee}\mathrm{for}1\mathrm{year}& =& 12\mathrm{month}\times \mathrm{Membership}\mathrm{fee}\mathrm{per}\mathrm{month}\\ & =& 12\times \$55\\ & =& \$60\end{array}$

On average, customers renew annual membership three times, that means,

$\begin{array}{rcl}\mathrm{Annual}\mathrm{membership}\mathrm{fee}\mathrm{for}3\mathrm{years}& =& \mathrm{Membership}\mathrm{fee}\mathrm{per}\mathrm{year}\times 3\mathrm{years}\\ & =& \$60\times 3\\ & =& \$180\end{array}$

Nate pays $100 to BlueBox as initiation fees

$\begin{array}{rcl}\mathrm{Total}\mathrm{revenue}\mathrm{recognized}\mathrm{in}4\mathrm{years}& =& \mathrm{Annual}\mathrm{membership}\mathrm{fee}\mathrm{for}3\mathrm{years}+\mathrm{Initiation}\mathrm{fee}\\ & =& \$180+\$100\\ & =& \$280\\ \mathrm{Revenue}\mathrm{recognized}\mathrm{in}\mathrm{first}\mathrm{year}& =& \frac{\mathrm{Total}\mathrm{revenue}\mathrm{recognized}\mathrm{in}4\mathrm{years}}{4}\\ & =& \frac{\$280}{4}\\ & =& \$70\end{array}$