The Unearned Revenue Liability and Firm Value: Evidence from the Publishing Industry

Abstract

When customers prepay for goods or services, accounting practice requires that the cash inflow to the firm be classified as a liability (unearned revenue liability) until delivery to the customer. While there are eventual cash outflows associated with customer prepayments (equal to the marginal cost of producing the good or service), an argument can be made that the book liability actually represents an economic asset. As long as the firm is selling its product above cost, the cash outflows associated with future delivery are less than the cash advance received currently. Therefore, a net economic asset exists, equal to the difference between the cash received and the cost of the goods to be delivered. This paper utilizes a sample of firms from the magazine and periodicals publishing industry to examine the relation between the book liability for unearned revenue and firm equity value. The empirical tests provide strong evidence that stock prices behave as if the unearned revenue liability represents an economic asset. Further, the valuation of the asset is negatively related to the variable costs of production. The study also examines the association between the unearned revenue liability, current sales, and future sales. The empirical analysis provides evidence that the change in next-year sales is related to the change in current year sales conditioned on the change in the unearned revenue liability. In other words, sales increases in the current year do not persist into the future unless accompanied by an increase in the unearned revenue liability.