St.
Thomas Auto Repairs is preparing the financial statements for the year ended
November 30, 2010. As the accountant, you are looking over the information
regarding short-term liabilities, and determining the amounts that should be
reported on the balance sheet. St. Thomas Auto Repairs reports under private
enterprise accounting standards. The following information regarding new
corporate initiatives has been brought to your attention.
1.
The company printed a coupon in the local newspaper in November 2010. The
coupon permits customers to take 10% off the cost of any service between
November 1, 2010, and January 30, 2011. The newspaper has a circulation of
10,000 customers. In November, 5 coupons were used, resulting in sales
reductions of $250. It is expected that 50 more coupons will be used before
January 30, and the average sales transaction for the company is $75.
2.
In order to reduce the costs associated with sick time, the company developed a
new plan in 2010. Employees are per mitted up to six sick days per year with
pay. If these days are not all used, then 50% of the unused time will be accumulated
and can be used as sick pay or the employee can use the time as paid vacation
within the next year; otherwise, the rights will expire at the end of the next
fiscal year. During 2010, the two employees each used two of their six days.
The
daily rate of pay for each employee is $100. These two individuals are
long-term employees of the company who are unlikely to resign in the near
future and who have been relatively healthy in the past.
3.
The company is considering starting a customer loyalty program. The program
would involve tracking the purchases of each customer on a small card that is
retained by the customer. Each time a customer reaches $250 in total purchases,
a $10 discount would be offered on the next purchase.
Instructions
(a)
For items that affect the 2010 financial statements, determine the amount of
any liability that should be reported and the related expense.
(b)
Discuss the issues that the proposed customer loyalty program raises from an accounting
standpoint. Explain how the program should be accounted for.
(a)
(i)
Coupon
Estimated
promotion expense to be reported on income statement:
|
Remaining
estimated redemptions of coupons
|
|
|
(50 coupons to be used in future
|
|
|
X 10% discount X $75 average sale)
|
$375
|
|
Coupons already used
|
250
|
|
Total promotion expense
|
$625
|
Balance
sheet disclosure:
Unredeemed coupons liability $375
(ii)
Sick time
As
it is possible that these amounts will be paid in the future, and there is
little likelihood that the employees will resign, the full amount should be
accrued.
Balance
Sheet:
Sick time payable:
(2 employees X $100/day X 4 days X
50%) $400
Income Statement:
Increase to wage expense on the income statement:
- For the sick days taken in 2010:
(2 employees X 2 days each X $100/day) $400
- For the sick days outstanding related to the liability:
(2 employees X $100/day X 4 days X 50%)
400
$800
(b) The
customer loyalty program offers future discounts of $10 for accumulating sales
of $250. These types of programs are evaluated as a revenue arrangement with
multiple deliverables. The fair value of
the award credits should be recognized as unearned revenue, a liability, with
each sale. When customers redeem their award credits, the amount is recognized
as revenue.
However,
not all of the awards will be redeemed, as customers may lose their card, move
away, or forget to redeem their award once it is earned. Once the company has
some experience in order to estimate how many award credits will be redeemed,
compared to the total credits awarded to customers, some adjustment can be made
to the liability account at year end.
A
liability must be recorded as each customer earns sales “credits” towards the
$250 total. The fair value of each credit given for each dollar of sales is
$0.04 ($10/$250). Therefore, each sale to a customer who is a member of the
customer loyalty program must be split, with 4% of the sale being recorded as
unearned revenue, and the balance as a sale in the period of the transaction.
When the customer accumulates $250 in credits, and comes in to receive their
$10 discount, this amount will be adjusted from unearned revenue to sales.
