FRA question

Which of the following is the least likely impact of increased unearned revenue that is taxable?

  1. The company’s liquidity increases.

  2. The company’s return on equity decreases.

  3. The company’s deferred tax asset decreases.

You Answered Incorrectly.

Unearned revenue increases deferred tax asset as it increases the taxable revenue if the cash collected as unearned revenue is taxable under the tax laws.

Correct answer is 3, and I choose 1.

Why 1 is not the answer ? Unearned revenue will result in the decrease of the liquidity ration. Besides, I still don’t understand why 3 is correct ?

you are reading questions INCORRECTLY. They are asking for LEAST LIKELY IMPACT. So 1 is correct. It has revenue - so liquidity increases. 2 is correct - because taxes increase - so NI decreases - so ROE decreases.

But Deferred tax asset increases - while they said it decreases. So 3) is the right answer.

Thanks ! I thought unearned revenue is liability resulting in decline of liquidity ratio, so I choose 1.

Actually you are right. unearned revenue is liability and would not be recognized as revenue until the firm delivers the good or service. Liquidty increases because firm collect cash prior to the revenue recognition. The tricky part in the question is it says the unearned revenue is taxable and I dont have an explanation about it either :slight_smile: