The Unearned Revenue Liability and Firm Value:

Evidence from the Publishing Industry

Mark P. Bauman
University of Illinois at Chicago
Department of Accounting (MC 006)
601 S. Morgan Street
Chicago, IL 60607-7123
Phone: 312-996-5289 Fax: 312-996-4520
E-mail: mpbauman@uic.edu

August 2000

I thank Chris Bauman, Bob Halsey, and Paul Kimmel for helpful comments.
 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.

Key Words: Unearned revenue, Valuation, Sales prediction.

Data Availability: All data are available from public sources.

1

THE UNEARNED REVENUE LIABILITY AND FIRM VALUE:

EVIDENCE FROM THE PUBLISHING INDUSTRY

I. INTRODUCTION

Under current accounting practice, the amount of cash prepaid by customers is

classified as a liability ("unearned revenue liability") pending delivery of the goods or

services. While waiting until completion of the earnings process to recognize the cash

proceeds as revenue is fully consistent with revenue recognition under accrual

accounting, this treatment may not reflect the underlying economics of the transaction. If

so, the relation between accounting data and firm value is obscured.

The primary purpose of this paper is to empirically examine the manner in which

the unearned revenue liability maps into firm equity value. This is of interest as it

encompasses fundamental issues at the foundation of financial accounting theory and

practice. First, it examines the usefulness of balance sheet accruals in a specific context.

Accounting practice is based on the notion that the accrual accounting process results in a

superior measure of firm performance over short time periods (FASB 1978).1 By

transforming firm cash flows, accruals and deferrals enable the matching of efforts with

accomplishments. However, given the widely accepted notion that firm value is equal to

the present value of future cash flows, the accrual accounting system may fail to record

increments in firm value on a timely basis when customers prepay for goods and services.

In this case, the revenue recognition principle does not permit an increase in shareholders'

equity until the firm "has substantially accomplished what it must do to be entitled to the

benefits represented by the revenues" (FASB 1984, ¶ 83).

2

The study addresses the reliability (especially representational faithfulness) of the

unearned revenue liability. The manner in which the unearned revenue liability is valued

by investors is particularly interesting as there are opposing views as to how it maps into

stock price. Accounting standard setters focus on the inevitable cash outflows. When the

goods or services are delivered, the cash outflows associated with the unearned revenue

liability are the marginal costs of providing the good or service. If the promised goods or

services are ultimately not delivered, the firm refunds the prepayment and the book

liability is equal to the amount of cash advanced. Under this liability view, the unearned

revenue liability is negatively related to firm value. An alternative view is proposed in

this study. The economic asset view characterizes customer prepayments as net cash

inflows (assuming the firm is selling above marginal cost). As prepayments give rise to

cash inflows ultimately confirmed by accounting profits, they represent an

understatement of firm value. Under the economic asset view, the unearned revenue

liability is positively related to firm value.

The value relevance of the unearned revenue liability is examined by conducting

price-level valuation tests on a sample of firms involved in the magazine and periodicals

publishing industry. The chosen research design mitigates two potential econometric

problems associated with "levels-based" regression models -- correlated omitted variables

and scale effects. To address the omitted variables issue, the sample is limited to firms

engaged in similar lines of business. In addition, fixed time and firm effects are included

in the model. Scale effects are controlled for by including a scale proxy as an independent

variable in the model (Barth and Kallapur 1996). Sensitivity analysis is performed by

employing alternative scale proxies.

3

The empirical price-level tests provide evidence in support of two hypotheses.

First, the evidence strongly supports the conclusion that stock prices behave as if the

unearned revenue liability represents an economic asset. In this regard, the magnitudes of

the coefficient estimates imply that investors consider the annuity associated with

renewals and new subscribers. Second, the pricing of the unearned revenue liability is

negatively related to the variable costs of production. This is consistent with the

economic asset being valued in part on its liability characteristics. The liability/equity

hybrid nature of the unearned revenue liability suggests that current accounting practice

fails to capture relevant information concerning firm value.

The study also examines the association between the unearned revenue liability,

current sales, and future sales. This is an important issue as it addresses the manner in

which financial statement information is useful in assessing future results of operations.

The empirical analysis provides evidence that the change in current-year sales is

informative about the change in next-year, conditional on the change in the unearned

revenue liability. Thus, sales increases in the current year do not persist into the future

unless accompanied by an increase in unearned revenue from either price increases or

new subscribers.

The paper is organized as follows. Section II describes the motivation for the

paper and develops the hypotheses. The empirical models are described in section III.

The sample selection procedure and descriptive statistics are presented in section IV.

Section V presents the empirical results, while section VI concludes.

4

II. MOTIVATION AND HYPOTHESIS DEVELOPMENT

Existing Literature

Empirical studies examining balance sheet valuation issues take two basic

approaches. Under the first approach, the research question focuses on recognized assets

and liabilities. These studies generally test whether the market values specific assets and

liabilities. Examples include the nonperforming assets portion of bank loan portfolios

(Beaver et al. 1989), regulatory assets in rate-regulated firms (Loudder, Khurana, and

Boatsman 1996), the liability for postretirement benefits other than pensions (Amir

1996), and deferred tax assets and liabilities (Amir, Kirschenheiter, and Willard 1997,

Ayers 1998, Amir and Sougiannis 1999).

Studies under the second approach examine whether the market prices

unrecognized (or “economic”) assets and liabilities. Examples include assets and

liabilities of pension plans (Landsman 1986, Barth 1991, and Barth, Beaver, and

Landsman 1992), obligations under postretirement benefit plans other than pensions

(Amir 1993), environmental liabilities (Barth and McNichols 1994), research and

development "assets" (Sougiannis 1994), and fair values of financial instruments

disclosed in footnotes (Barth, Beaver, and Landsman 1996).

The present study employs a sample of firms in the publishing industry to

examine the relation between the unearned revenue liability and firm value.2 In this

manner, both the relevance and reliability of the liability is examined. As in the above-

referenced studies examining the pricing of reported balance sheet items, the question of

whether market participants value the book liability addresses the relevance of the

measure.
5

Of particular interest in the current study is the reliability of the unearned revenue

liability measure. Under the conceptual framework of accounting, “representational

faithfulness” (a component of reliability) is defined as follows (FASB 1980, ¶63).

Representational faithfulness is correspondence or agreement between a

measure or description and the phenomenon it purports to represent. In
accounting, the phenomena to be represented are economic resources and
obligations…

As described above (and expanded on in the following section), there are diametrically

opposing views as to how the book liability maps into stock price. Under current

accounting practice, customer prepayments are classified as a liability (economic

obligation). However, from a firm valuation perspective, it can be argued that the book

liability actually represents an economic resource. The central purpose of this study is to

examine this issue.

Hypotheses

In certain industries (such as publishing of periodicals), it is common for

customers to prepay for goods or services. Under generally accepted accounting

principles, the cash inflow to the firm is not classified as revenue until the period in

which the goods are delivered or services rendered. The amount prepaid is classified as a

liability pending completion of the earnings process. Statement of Financial Accounting

Concepts No. 6, Elements of Financial Statements, states that "prepayments received for

goods or services to be provided…qualify as liabilities under the definition because an

entity is required to provide goods or services to those who have paid in advance" (¶

197).
 6

It is clear that there are cash outflows associated with the book liability. The

amount of the eventual outflow depends on whether or not the promised goods or

services are delivered to the customer. In the typical case in which the goods or services

are delivered to the customer, the cash outflow is equal to the marginal cost of producing

the goods or services. If the firm does not deliver, it would be obligated to refund the

prepayment and the book liability would be exactly equal to the amount of cash

advanced.

While there are cash outflows associated with customer prepayments, an

argument can be made that the book liability actually represents an economic asset.

Ignoring the case where the promised goods or services are not delivered, each dollar of

unearned revenue generally does not result in one dollar of cash outflow. As long as the

firm is selling above cost, the cash outlay will be less than the cash advanced. In this

case, the book liability corresponds to a net cash inflow to the firm. Further, to the extent

that new subscriptions and renewals exceed cancellations, the book liability represents a

perpetual source of tax-advantaged net cash inflows to the firm.3

Daily Journal Corp. reflects this notion in its financial reports. The “Selected

Financial Data” section of its 1997 Form 10-K includes the following presentation.

1997 1996 1995 1994 1993

Working capital as conventionally reported $4,763 $1,552 $(166) $(922) $(2,927)
Working capital before deductions of specified items (1) 11,165 8,706 5,632 4,757 2,324

(1) Before deducting for each of the five years the liability for deferred subscription revenue which will be
earned within one year.

Despite the fact that cash outflows will occur, management of Daily Journal Corp.

does not view unearned revenue as a liability.

7

The "economic asset" view leads to the following hypothesis (stated in alternate

form).

H1: The book liability for unearned revenue is positively related to equity value.

The cash outflow associated with the unearned revenue liability is an increasing

function of the variable costs of production. Ceteris paribus, if the book liability is valued

as an economic asset, the value of the asset is decreasing in the variable cost of

production. This leads to the following hypothesis (stated in alternate form).

H2: The relation between the book liability for unearned revenue and equity
value is decreasing in the extent of variable production costs.

Bernard (1995) asserts that the ultimate objective of research on the relation

between accounting data and firm value is a focus on predicting future earnings and

growth in book value. A first step in forecasting future earnings is the prediction of future

sales. While annual sales growth rates are mean reverting to a range of 7 to 9 percent over

time, systematic differences tend to persist for up to 3 or more years (Palepu, Healy, and

Bernard 2000). Thus, the current level of sales provides a good starting point for

predicting future sales of established companies.

When customers prepay for goods or services, the change in the unearned revenue

liability provides additional information to financial statement users regarding the level

of future sales. As the unearned revenue liability reflects customers’ intention to receive a

given product or service, it is reasonable to expect that changes in the liability provide a

more direct indicator of future sales growth than does past sales growth. This leads to the

third hypothesis (stated in alternate form).

H3: After controlling for the change in the unearned revenue liability, the change
in next-year sales is unrelated to the change in current year sales.
8

III. EMPIRICAL MODELS

Market Valuation of Unearned Revenue Liability

Consistent with the theoretical work of Ohlson (1995), the market value of a

firm’s equity interest at time t (Pt ) can be modeled as

Pt = α1 NI t + α2 BVt + α3 NONFIN t (1)

where NI represents net income, BV is the book value of equity, and NONFIN represents

value-relevant non-financial information not yet captured by the accounting system. This

model incorporates a number of important valuation concepts. Price can be expressed

solely in terms of current earnings only when current earnings is perfectly persistent. In

addition, price can be expressed solely in terms of current book value only when current

earnings have no persistence and the accounting is unbiased (Feltham and Ohlson 1995).

In less extreme cases, both current earnings and book value are informative about price.

To the extent stock prices reflect information other than that contained in financial

statements, the NONFIN term is included.

The empirical model for testing H1 and H2 is derived through several

modifications to equation (1). First, the liability for unearned revenue (UR) is added back

to book value and included as a separate term. This is done in order to isolate the effect of

the unearned revenue liability on equity value. Book value, adjusted for UR, is denoted as

BV*.

Next, a term reflecting the variable costs of production (VC) is added. To test

whether the valuation of the unearned revenue liability varies based on production cost

structure, a separate term interacting UR and VC is added.

9

Finally, as NONFIN is unidentifiable, an intercept term is added to capture the

mean effect of this information. To the extent that stock prices reflect time and firm-

specific information other than net income and book value, the addition of a single

intercept term cannot be expected to fully capture the effect of non-financial information.

To address this possibility of correlated omitted variables, fixed firm and time effects are

also included. By controlling for unobserved firm and time characteristics, specification

bias is reduced.

These modifications lead to the following pooled, cross-sectional model.4

Pi ,t = β0 + βi + βt + β1 NI i , t + β2 BVi *,t + β3URi , t + β4 URi , t ⋅ VCi ,t + εi , t (2)

The coefficient β 3 reflects how the unearned revenue liability maps into stock

price. If UR is valued as an economic asset (H1), β 3 >0. H2 asserts that the value of the

asset is decreasing in the marginal cost of production. Thus, H2 is supported if β 4 <0.5

Prediction of Next -Year Sales

The third hypothesis asserts that the change in next-year sales is unrelated to the

change in current year sales, after controlling for the change in the unearned revenue

liability. H3 is tested using the following model

∆SALES i , t = φ0 + φ1 ∆SALES i ,t −1 + φ2 ∆SALES i ,t −1 ⋅ ∆URi , t −1

(3)
+φ3 ∆SALES i ,t − 2 + φ4 ∆SALES i , t −3 + εi ,t

where ∆SALES represents the change in annual sales (scaled by sales from the prior

year), and ∆UR is the change in the unearned revenue liability (scaled by the unearned

revenue liability from the prior year). The ∆SALESt-1 and ∆URt-1 terms are interacted to

measure the effect of changes in the unearned revenue liability on the persistence of the
10

most recent sales change. H3 is supported if φ 1 =0 and φ 2 >0. The ∆SALESt-2 and

∆SALESt-3 terms are included to control for information reflected in past sales history.

IV. SAMPLE SELECTION AND DATA

Firms with primary SIC codes of 2711 (Publishing-Newspapers) and 2721

(Publishing-Periodicals) as well as firms classified as newspaper or periodical publishers

by Wall Street Research Net (wsrn.com) are considered for inclusion in the sample. A

total of 33 firms are identified in this manner.

All data employed in this study (other than the unearned revenue liability) are

obtained from Compustat PC Plus. Data regarding unearned revenue are gathered from

annual or Form 10-K reports from 1991 through 1997. After considering data constraints,

a sample of 22 firms comprising 142 firm-year observations is available for estimating

model (2). In contrast, 98 firm-year observations are available for estimating model (3)

due to the “changes” specification and the inclusion of lagged dependent variables. The

sample firms are identified in appendix A. Annual sample size information is presented in

table 1.

[insert table 1 about here]

Table 2 presents descriptive statistics for the variables employed in the study

(appendix B identifies how the variables are measured). The liability for unearned

revenue (UR) can be very significant. The median as a percent of book value is 6.9%,

while the third quartile is 45.2%. Changes in UR can also be significant, with a median

change of 6.1% and a third quartile value of 11.7%. As indicated in appendix B, NI is

adjusted for nonrecurring items. Net losses are reported in 13 of the 142 observations,
11

while only one adjusted book value figure is negative. Given that the variable costs of

production should range between 0 and 1, the estimates of VC do not appear

unreasonable (first and third quartile values of 0.148 and 0.716, respectively).6 As

expected, the sales change amounts are similar due to pooling of current and lagged

values.7

[insert table 2 about here]

Correlation matrices are presented in table 3. Panel A includes the variables used

for testing the market valuation of the unearned revenue liability (H1 and H2). The

Pearson correlation coefficients (upper triangle) are noteworthy in two respects. First,

although positive, the correlation between P and NI (0.056) is not significantly different

from zero. Second, the Pearson correlations between NI and the remaining variables have

the opposite sign from the corresponding Spearman rank correlations (lower triangle). A

scatter plot of P on NI reveals that these results are due to observations with negative NI.8

The Spearman correlation between price and net income (0.635) is not as heavily

influenced by observations with negative NI.

[insert table 3 about here]

Panel B of table 3 includes the variables used in the sales prediction analysis

(H3). Two results indicate that the Pearson correlations are influenced by extreme

observations. First, only the correlation between sales changes in years t and t- 3 (-0.266)

is significantly different from zero. Second, the Spearman rank correlation between these

same two variables (0.061) is not significantly different from zero. With respect to the

remaining Spearman correlations, first and second degree autocorrelation in sales

changes is evident. The rank correlation coefficients between sales changes for years t
12

and t-1 (0.296), t-1 and t-2 (0.256), and t-2 and t-3 (0.332) are all significant. In addition,

the correlation between sales changes for years t and t-2 (0.261), and t-1 and t-3 (0.275)

are also significant.

V. EMPIRICAL RESULTS

Valuation of the Unearned Revenue Liability

Main results

The results of estimating model (2) are reported in table 4. In panel A, VC is

measured as a continuous variable winsorized at 0 and 1 (see appendix B). The first row

presents results using all firm-year observations (fixed firm and time effects not

reported). Consistent with H1, the coefficient estimate for the UR term (18.297, White

t=2.40) is positive and significant at better than the 0.05 level, one-tailed test.9 The sign

of the coefficient implies that the market treats the book liability as an economic asset,

while its magnitude reflects an annuity-type valuation. Consistent with H2, the estimate

for the interaction of UR and VC (-6.921, White t=-1.60) is significantly less than zero at

the 0.056 level, one-tailed test. This result implies that the value of the economic asset is

decreasing in the variable costs of production.

[insert table 4 about here]

The remaining coefficient estimates are generally consistent with expectations.

The coefficient for NI (17.718, White t=3.32) is significantly greater than zero.10 The

coefficient estimate for BV* (1.002, White t=2.61) is also significantly greater than zero.

The adjusted R-squared for the model is 0.904. Omitting the fixed effects, the adjusted R-

squared drops to 0.801. Thus, although the sample firms are all involved in the publishing
13

industry, the fixed firm and time effects appear to capture additional effects of omitted

variables.

The sensitivity to influential observations of the above results is examined in the

second row of panel A. Specifically, the second row presents the results of estimating

model (2) after excluding those observations resulting in studentized residuals with an

absolute value in excess of 3. The result for H1 does not change as the coefficient

estimate for UR (6.696, White t=2.14) remains significantly different from zero.

However, H2 is no longer supported as the coefficient estimate for UR⋅VC (-0.353,

White t=-0.18) is not significantly different from zero.

To examine the possible effect of measurement error in computing the variable

costs of production, model (2) is re-estimated with an alternative definition of VC. In

panel B of table 4, VC is defined as an indicator variable equal to 1 if the continuous

variable cost measure is greater than the sample median (and 0 otherwise). The first row

presents results using all firm-year observations. Consistent with H2, the coefficient

estimate for UR⋅VC (-7.628, White t=-2.91) is significantly negative when this

alternative definition of VC is used. As reported in the second row of panel B, the

significance of the coefficient estimate (-4.447, White t=-2.41) is robust to the exclusion

of extreme observations. Overall, H2 is supported. In addition, the results with respect to

H1 are unchanged when VC is defined as an indicator variable.

Tests for effect of scale differences

Levels-based regression models may result in spurious inferences due to the

effects of interfirm scale differences (Barth and Kallapur 1996, Barth and Clinch 1999).

In this regard, Barth and Kallapur (1996) recommend including a scale proxy as an
14

independent variable and reporting inferences based on White (1980) standard errors as

the most effective means to mitigate scale bias. Thus, sensitivity analysis is conducted by

estimating the following model

Pt = β0 + βi + βt + β1 NI it + β2 BVit* + β3URit + β4 URit ⋅ VCit + β5 SCALE + εt (4)

where SCALE represents a proxy for scale differences between firms.

The results of estimating model (4) are presented in table 5. In panel A, VC is

measured as a continuous variable. Coefficient estimates are reported using three

common proxies for scale -- common shares outstanding, total assets, and total sales

(based on full sample and with influential observations deleted).11 Several results are

noteworthy. First, the magnitude of all coefficient estimates is generally lower than in

table 4, possibly reflecting a reduction in scale bias. With respect to the hypothesis tests,

H1 is strongly confirmed as each of the six reported coefficient estimates for UR is

significantly positive at the 0.05 level or better (one-tailed test). The results with respect

to H2 are mixed. When using outstanding shares as a scale proxy, neither of the

coefficient estimates for UR⋅VC is significantly different from zero. However, three of

the four estimates using assets and sales as scale proxies are significantly negative at

levels ranging from 0.054 to 0.063 (one-tailed test). Thus, H2 is weakly supported when

VC is measured as a continuous variable.

[insert table 5 about here]

In panel B of table 5, VC is defined as an indicator variable. Once again, the

results for H1 are strongly confirmed (the smallest White t- statistic for the UR coefficient

estimate is 2.18). Contrary to panel A, the results more strongly support H2. When

common shares outstanding is used as a scale proxy, the coefficient estimate for UR⋅VC
15

based on all observations (-3.259, White t=-1.43) is significantly negative at the 0.077

level. When assets or sales is employed as a scale proxy, three of the four coefficient

estimates for UR⋅VC are significantly negative at better than the 0.05 level. Thus, it

appears that error in measuring VC as a continuous variable is responsible for the mixed

results with respect to H2 in panel A of table 5.

Overall, the results of testing H1 are robust over different model specifications.

While the results for H2 vary somewhat across the definition of VC, the evidence

generally supports H2.12

Prediction of Next -Year Sales

H3 asserts that the change in next-year sales is unrelated to the change in current

year sales, after controlling for the change in the unearned revenue liability. In this

regard, the results of estimating model (3) via OLS are presented in table 6.13

Panel A of table 6 presents the results using untransformed variables. The first

row presents a benchmark model that excludes the ∆SALES⋅∆UR interaction term. The

coefficient estimates for the first two lags of change in sales are positive (0.1941, White

t=1.56 and 0.2006, White t=1.84) and significant at the 0.062 and 0.035 levels (one-tailed

test), respectively. The estimate for the third lag of change in sales is negative (-0.1862,

White t=-1.32). This is consistent with recent sales growth providing information

regarding future sales growth.

The results reported in the second row of panel A include the ∆SALES⋅∆UR term.

Contrary to H3, the coefficient estimate for φ 1 is marginally positive (0.1775, White

t=1.38), while the estimate for φ 2 is not significantly positive (0.1641, White t=0.32).14
16

[insert table 6 about here]

As indicated by the correlation data in table 3, there is evidence of a number of

extreme observations. To address this concern, the sensitivity of the above results to

influential observations is examined by performing a rank transformation on all

variables.15 The results are presented in panel B of table 6. The first row represents the

benchmark model (i.e., excluding the interaction of ∆SALES and ∆UR). Consistent with

panel A of the same table, the coefficient estimates for the first (0.2250, White t=2.22)

and second lag of change in sales (0.2090, White t=2.04) are significantly positive. The

coefficient estimate for the third lag is negative, but not significantly different from zero

(-0.0750, White t=-0.70). In contrast to panel A, the results including the ∆SALES⋅∆UR

term (second row) are consistent with H3. The coefficient estimate for the first lag of

change in sales, φ 1 , (0.0534, White t=0.38) is not significantly different from zero. In

addition, the coefficient estimate for φ 2 (0.3014, White t=1.69) is significantly greater

than zero at the 0.047 level, one-tailed test. Thus, it appears that the insignificant result in

panel A is due to influential observations. This result implies that sales increases in the

current year do not persist into the future unless accompanied by an increase in unearned

revenue from either price increases or new subscribers.

VI. SUMMARY AND CONCLUSIONS

This paper investigates the relation between equity value and the book liability for

unearned revenue for a sample of magazine and periodicals publishers. Evidence is

presented that stock prices behave as if the unearned revenue liability represents an

economic asset. This result indicates a lack of representational faithfulness in the

17

prescribed accounting treatment. It is further demonstrated that the valuation of the asset

is negatively related to the variable costs of production. Thus, while the book liability is

priced as an asset, it also possesses "liability-like" properties. These results have

implications for accounting policymakers. In particular, the hybrid nature of the book

liability suggests that an increase in shareholders’ equity be recorded in association with

customer prepayments.

The study also examines the association between changes in the unearned revenue

liability and future sales. Evidence is presented that the change in next-year sales is

unrelated to the change in current year sales, after considering the change in the unearned

revenue liability. On average, sales increases in the current year do not persist into the

future unless accompanied by an increase in unearned revenue. This result has

implications for financial statement users interested in projecting future results of

operations.

Overall, the study adds to our understanding of the relation between accounting

data and firm value. As the sample is confined to magazine and periodical publishers, a

useful extension would be to examine unearned revenue in other industries.

18

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test for heteroscedasticity. Econometrica 48: 817-838.
21

Appendix A
Identification of Sample Firms

# of
Firm observations

American Media Inc 5

Belo (AH) Corp 7
Central Newspapers 7
Daily Journal Corp 7
Dow Jones & Co Inc 7
EW Scripps 7
Gannett Co 7
Harte Hanks Communications 5
Knight Ridder Inc 7
Lee Enterprises 7
McClatchy Newspapers 7
Media General 6
Meredith Corp 7
New York Times Co 6
Playboy Enterprises 7
Plenum Publishing Corp 6
Reader's Digest Association Inc 7
T/SF Communications Corp 5
Time Warner Inc Holdings 7
Times Mirror Company 6
Tribune Co 5
Washington Post 7

Total 142
22

Appendix B
Measurement of Variables

Variable Description Measurement (Compustat data item # in parentheses)

P Market value of common equity Shares outstanding (#25) x Price at fiscal year close (#199)

NI Net income available to common Income before extraordinary items available for common (#237)
+ Restructuring charges (net of tax effect)
± Gains (losses) in excess of 10% of income before taxes (net of tax effect)

BV* Adjusted book value Common equity (#60) + Unearned revenue liability

UR Unearned revenue liability Collected from annual report or Form 10-K

VC Variable costs of production Cost of goods sold t (#41) − Cost of goods sold t −1
Sales t (#12) − Sales t −1

(values < 0 are set to 0; values > 1 are set to 1)

∆SALES Change in sales Sales t − Sales t −1

Sales t −1

∆UR Change in unearned revenue UR t − UR t −1

UR t −1
23

Table 1
Sample Size by Year

Firm-year observations for Firm-year observations for

testing H1 and H2 testing H3

1991 14 --

1992 18 --

1993 22 14

1994 22 18

1995 22 22

1996 22 22

1997 22 22

Total 142 98
24

Table 2
Descriptive Statistics (dollar amounts in millions)

Variable (1) # obs Mean SD 25% 50% 75%

UR 142 106.37 156.82 12.10 37.79 104.51

UR/BV 142 0.267 0.399 0.038 0.069 0.452

∆UR 98 0.103 0.259 0.021 0.061 0.117

P 142 2970.32 4493.68 503.44 1310.10 3712.64

NI 142 80.40 160.01 12.63 51.68 148.09

BV* 142 1056.39 1626.07 230.76 513.67 1303.26

VC 142 0.649 2.874 0.148 0.437 0.720

∆SALESt 98 0.062 0.103 0.022 0.063 0.106

∆SALESt-1 98 0.054 0.088 0.022 0.059 0.103

∆SALESt-2 98 0.040 0.092 0.012 0.046 0.091

∆SALESt-3 98 0.037 0.104 0.002 0.035 0.080

(1) See appendix B for variable definitions.

25

Table 3
Correlation Matrices (1)
(Pearson above diagonal; Spearman below diagonal)

Panel A: Variables for testing H1 and H2 (2)

P NI BV* UR UR*VC

P 0.056 0.829 0.722 0.591

NI 0.635 -0.238 -0.273 -0.369

BV* 0.929 0.586 0.721 0.605

UR 0.723 0.335 0.748 0.855

UR*VC 0.413 0.094 0.421 0.577

Panel B: Variables for testing H3 (2)

∆SALESt ∆SALESt-1 ∆SALESt-2 ∆SALESt-3 ∆URt-1

∆SALESt 0.134 0.160 -0.266 0.125

∆SALESt-1 0.296 0.126 0.114 0.075

∆SALESt-2 0.261 0.256 0.135 -0.052

∆SALESt-3 0.061 0.275 0.332 0.012

∆URt-1 0.197 0.114 -0.088 -0.012

(1) Correlations significant at 0.05 level or better in bold face type.

(2) See appendix B for variable definitions.
26

Table 4
Relation between Unearned Revenue Liability and Equity Value (1)
[White (1980) t -statistics in parentheses]

Pi ,t = β0 + βi + βt + β1 NI i , t + β2 BVi *,t + β3URi , t + β4 URi , t ⋅ VCi ,t + εi , t

Panel A: VC measured as continuous variable (winsorized at 0 and 1)

β0 β1 β2 β3 β4
Observations N (?) (+) (+) (+) (-) Adj. R2

All 142 -513.528 17.718 1.002 18.297 -6.921 0.904

(-1.09) (3.32) (2.61) (2.40) (-1.60)

Influential observations deleted (2) 137 -46.333 12.049 1.331 6.696 -0.353 0.973
(-0.30) (4.36) (10.04) (2.14) (-0.18)

Panel B: VC represented as indicator variable (=1 if VC>sample median, =0 otherwise)

β0 β1 β2 β3 β4
Observations N (?) (+) (+) (+) (-) Adj. R2

All 142 -538.917 15.934 0.689 15.372 -7.628 0.917

(-1.22) (3.42) (1.99) (2.38) (-2.91)

Influential observations deleted (2) 139 -175.127 16.557 0.866 10.378 -4.447 0.960
(-0.91) (7.43) (4.63) (2.50) (-2.41)

(1) See appendix B for variable definitions.

(2) Defined as observations with studentized residuals with an absolute value in excess of 3.
27

Table 5
Sensitivity Tests for Effect of Scale (1)
[White (1980) t -statistics in parentheses]

Pi ,t = β0 + βi + βt + β1 NI i ,t + β2 BVi *,t + β3URi ,t + β4URi ,t ⋅ VCi , t + β5 SCALEi , t + εi ,t

Panel A: VC measured as continuous variable (winsorized at 0 and 1)

β0 β1 β2 β3 β4 β5
Scale proxy Observations N (?) (+) (+) (+) (-) (?) Adj. R2

Shares All 142 -2382.561 10.605 0.154 14.840 -2.760 47.391 0.940
(-3.99) (2.46) (0.45) (2.80) (-0.78) (4.55)

Influential observations deleted (2) 138 -1895.105 9.351 -0.046 8.792 0.558 39.437 0.974
(-6.43) (5.87) (-0.20) (3.25) (0.42) (7.43)

Assets All 142 -712.531 13.979 -1.106 10.657 -5.812 1.162 0.928
(-1.96) (3.22) (-1.83) (2.32) (-1.62) (3.55)

Influential observations deleted (2) 139 -326.206 14.965 -0.274 7.716 -2.770 0.718 0.963
(-1.91) (5.24) (-0.65) (2.18) (-1.56) (3.73)

Sales All 142 -495.325 17.690 1.086 18.067 -6.854 -0.133 0.903
(-0.97) (3.28) (2.53) (2.22) (-1.54) (-0.15)

Influential observations deleted (2) 137 -77.270 11.698 1.241 6.827 -0.289 0.260 0.973
(-0.46) (3.87) (5.58) (2.19) (-0.15) (0.65)

(1) See appendix B for variable definitions.

(2) Defined as observations with studentized residuals with an absolute value in excess of 3.
28

Table 5 (continued)
Sensitivity Tests for Effect of Scale (1)
[White (1980) t -statistics in parentheses]

Panel B: VC represented as indicator variable (=1 if VC>sample median, =0 otherwise)

β0 β1 β2 β3 β4 β5
Scale proxy Observations N (?) (+) (+) (+) (-) (?) Adj. R2

Shares All 142 -2213.026 10.540 0.105 13.846 -3.259 42.872 0.942
(-3.52) (2.41) (0.32) (2.88) (-1.43) (4.10)

Influential observations deleted (2) 138 -1103.474 11.673 0.286 8.138 0.393 23.587 0.978
(-3.80) (8.72) (2.86) (3.02) (0.56) (4.07)

Assets All 142 -665.404 13.896 -0.848 9.672 -4.218 0.943 0.929
(-1.78) (3.11) (-1.33) (2.23) (-1.79) (2.73)

Influential observations deleted (2) 138 -38.724 15.535 0.497 6.864 -0.415 0.074 0.966
(-0.22) (5.58) (1.20) (2.20) (-0.47) (0.38)

Sales All 142 -583.804 15.896 0.479 15.822 -7.993 0.305 0.916
(-1.23) (3.52) (0.94) (2.26) (-2.56) (0.38)

Influential observations deleted (2) 138 66.841 15.605 1.670 7.140 -2.217 -1.492 0.969
(0.34) (6.91) (8.22) (2.18) (-2.42) (-4.69)

(1) See appendix B for variable definitions.

(2) Defined as observations with studentized residuals with an absolute value in excess of 3.
29

Table 6
Relation between Changes in Unearned Revenue Liability and Future Sales (1)
[White (1980) t -statistics in parentheses]

∆SALES i , t = φ0 + φ1 ∆SALES i , t −1 + φ2 ∆SALES i ,t −1 ⋅ ∆URi , t −1 + φ3 ∆SALES i ,t − 2 + φ4 ∆SALES i ,t − 3 + εi ,t

Panel A: Untransformed variables

φ0 φ1 φ2 φ3 φ4
N (?) (+) (+) (+) (+) Adj. R2

98 0.0486 0.1941 ----- 0.2006 -0.1862 0.065

(4.73) (1.56) ----- (1.84) (-1.32)

98 0.0482 0.1775 0.1641 0.2069 -0.1896 0.058

(4.66) (1.38) (0.32) (1.84) (-1.34)

Panel B: Rank transformation of variables

φ0 φ1 φ2 φ3 φ4
N (?) (+) (+) (+) (+) Adj. R2

98 0.3369 0.2250 ----- 0.2090 -0.0750 0.077

(4.35) (2.22) ----- (2.04) (-0.70)

98 0.3275 0.0534 0.3014 0.2343 -0.0736 0.103

(4.46) (0.38) (1.69) (2.33) (-0.68)

(1) See appendix B for variable definitions.

30

NOTES

1
Dechow (1994) presents evidence in support of this assertion.
2
Bernard (1989, 99) suggests trading off large sample sizes "for the sake of achieving a deeper
understanding of the relations among accounting variables, and between those variables and
equity values."
3
If the liability to furnish a periodical does not extend beyond a 12-month period after receipt of
cash, a firm may elect (under IRC §455) to include the income in the tax years during which the
liability exists or in the tax year in which the cash is received. Since these cash flows may not be
taxed until products are shipped, customer prepayments represent a semi-permanent source of
cash to finance growth.
4
The variables are not scaled. Sensitivity analysis regarding scale differences is reported in
section V.
5
If customer prepayments are valued as a liability (i.e., H1 is not supported), the value of the
liability is increasing in the variable costs of production. Thus, a negative relation with equity
value is still expected.
6
VC is estimated as the change in cost of goods sold from year t- 1 to year t divided by the
change in sales over the same period. This method results in 22 values less than zero and 20
values greater than 1. As described in appendix B, these extreme values are winsorized at 0 and
1, respectively.
7
For example, ∆SALES for year t includes observations from 1993 through 1997, ∆SALES for
year t-1 covers 1992 through 1996, etc.
8
The Pearson correlation between price and net income for firms with positive (negative) NI is
0.965 (-0.209). In addition, the correlations between NI and the remaining variables are positive
(negative) for firms with positive (negative) NI.
9
All reported t statistics reflect the White (1980) adjustment for heteroscedasticity.
10
As described in appendix B, NI is adjusted for restructuring charges and other reported gains
(losses). When these adjustments to net income are not included, the coefficient estimate
declines to 6.511 (White t=1.66).
11
To the extent that (adjusted) book value of equity represents a scale proxy, model (2) can be
considered to include a control for scale differences.
12
Collinearity diagnostics are examined for all model estimations. In this regard, none of the
condition indices exceeds the rule-of-thumb value of 30 identified by Belsley, Kuh, and Welsch
(1980).
31

13
Given the potential for violation of the independent errors assumption underlying OLS, an
autoregressive error model is also estimated. As there is no evidence of significant
autocorrelation in the residuals at up to three lags, the parameter estimates do not differ from
OLS.
14
Adding fixed time effects to model (3) results in substantially similar parameter estimates
(results not reported).
15
Variables are first ranked by year. A fractional rank transformation is performed in order to
arrive at parameter estimates independent of the number of observations.