Unearned Revenue/Earnings Quality increase, driving, provide, revenue, reason

Matori

Question to all…
In one of the Scweser mock exams, it said that an increase in unearned revenue indicated a lower earnings quality but for some reason this does not sound right to me.
Can you anyone provide some help?  I know the test is over but this one is driving me nuts.
Thanks!

Analyze_This

Haha, yeah just kind of popped into my head so can’t shake it at the moment.  But how does it affect earnings quality?  Decrease or increase indicates higher/lower quality?

bbtomato

A lot more sense…it was just one of those topics I grappled with because (at least I think), decreases/increases unearned revenue can be open to interpretation (i.e. a decrease could mean recognizing too soon).
Oh well, does not matter now I guess.  Thanks for responding!

dmrktrading

Unearned revenue is a liability. Usually, a higher value under this account is more conservative and more representative of GAAP/IFRS. If this account decreases, you’re recognizing revenue on your books, so it allows management to boost top/bottom line.
Although subtle, this account can also be used as a “smoothing” item. Management may show more liabilities today so that they can recognize revenue later. So an increase in this account can also reflect a lower quality.
Ultimately, you need to look at the changes in this account over time. Looking at one year (in real life terms), won’t tell you anything.
The way the CFA texts have covered this: a huge decrease in this account is indicative of poor quality. So in that sense, Schweser is wrong. And I’m not surprised because Schweser is wrong in many other places.

bodhisattva

Thanks.  That is what I hate about Schweser.  I found many times that doing something the way they taught it conflicted with the actual CFA books.  Iguess it just pays to use the curriculum after all, regardless of how much information is present.

RoastBeef

Damn, Ivan. You beat me to the post before I could quote you. Your quote about unearned revenue being thin air was not completely accurate. Unearned revenue is part of the firm’s working capital. If managed properly, it can be a pretty robust source of cash. Heck, it is even interest-free money.

LBriscoe

Aha, ofcourse, and your clients are stupid. This source of cash comes early but it comes as a reduced amount of cash (early payment discounts). Therefore there is always unwinding of discount on deferred revenue (if material ofcourse). IAS 18 is unbeatable.
There is no interest-free money in this world.

Colum

Ohh man, I’m just too tired of all this. Simply not excited about this stuff. Sorry for not wishing to argue. However,  you definetely have a point.

giants2010

LOL, I love you, too, Ivan. I’m just trying to make stupid posts on AF to try and not think of July 23rd. No matter how much I try though, the sucky feeling won’t go away. All day, I keep asking myself: what if I fail and what if I pass.

chandsingh

Unearned revenue comes about when you already receive the cash, but have not performed the service. Therefore, recognizing UR does not increase your future revenue. What is increased when you release the UR is your profit, artificially.
That said, either an increase or decrease in UR could be indicative of lower earnings quality. Decrease, for obvious reason. Increase, because you haven’t known the actual expense that would be incurred yet. For all you know, it could be well above the cash you received.