One month after you sell the subscription, which of the following statements best describes the impact on the financial statements?

One month after you sell the subscription, which of the following statements best describes the impact on the financial statements?

• A. Revenue increases by 1; Net income increases by 0.6; Cash flow from operations decreases by 0.4; Unearned revenue decreases by 1.
• B. Revenue increases by 1; Net income increases by 0.6; Cash flow from operations increases by 0.6; Unearned revenue decreases by 1.
• C. Revenue increases by 0.5; Net income increases by 0.3; Cash flow from operations decreases by 0.2; Unearned revenue decreases by 0.5.
• D. Revenue increases by 1; Net income increases by 0.6; Cash flow from operations increases by 0.4; Unearned revenue decreases by 1.

Answer: (D)

When you sell a subscription and collect cash upfront, that cash is recorded as unearned revenue, a liability, because you’ve taken payment before delivering the service. One month later, you’ve earned the revenue, so the liability should decrease and revenue should be recognized. In this scenario, unearned revenue decreases by the full amount and revenue increases by the same amount. The income statement shows revenue rising by 1. At the same time, there’s a cost to deliver the service for that month, which is 0.4. This cost reduces net income, so net income rises by 1 minus 0.4, which is 0.6. For the cash flow from operations, the cash was already received when the subscription was sold, so there isn’t a new cash inflow this month from that sale. However, the 0.4 cost recognized is a non-cash adjustment (it reduces net income but doesn’t require cash in this period’s CFO calculation), so you add it back when converting accrual to cash flow. This results in cash flow from operations increasing by 0.4. So the month’s effects are: revenue up 1, net income up 0.6, cash flow from operations up 0.4, and unearned revenue down 1. This matches the best description.

When you sell a subscription and collect cash upfront, that cash is recorded as unearned revenue, a liability, because you’ve taken payment before delivering the service. One month later, you’ve earned the revenue, so the liability should decrease and revenue should be recognized. In this scenario, unearned revenue decreases by the full amount and revenue increases by the same amount.

The income statement shows revenue rising by 1. At the same time, there’s a cost to deliver the service for that month, which is 0.4. This cost reduces net income, so net income rises by 1 minus 0.4, which is 0.6.

For the cash flow from operations, the cash was already received when the subscription was sold, so there isn’t a new cash inflow this month from that sale. However, the 0.4 cost recognized is a non-cash adjustment (it reduces net income but doesn’t require cash in this period’s CFO calculation), so you add it back when converting accrual to cash flow. This results in cash flow from operations increasing by 0.4.

So the month’s effects are: revenue up 1, net income up 0.6, cash flow from operations up 0.4, and unearned revenue down 1. This matches the best description.