Analysis of Promotional Activities A_ special promotional program established by Hoover Europe, a subsidiary of Maytag Corporation, offered free airline flights within Europe for qualified buyers of Hoover products during the period August 1992 to January 1993. Based on the expected cost of the program, Hoover Europe recorded $12.2 million of selling and general and administrative costs in 1992 related to the program and established an estimated liability.

Unfortunately, the program was structured such that customers could obtain free flights worth more than the selling prices of the Hoover products they purchased, and the public quickly took advantage of the promotional offer. In 1993, Hoover recognized promotional costs of $10.4 million for the program as a part of selling and general and administrative costs and a special $50 million expense to cover the additional unexpected cost of the program, raising the total expense recognized in 1993 for the program to $60.4 million. The financial statements of Hoover Europe are consolidated with other units of Maytag Corporation for financial reporting purposes.

For the year 1993, Maytag Corporation reported net income of

$51.2 million on total sales of $2,987 million.

a. What was the total cost of the program before taxes for Maytag?

b. What was the reduction in reported net income (after considering income taxes) for Maytag for 1993? Assume that the effective tax rate for Hoover Europe was 20 percent.

c. What actions might Hoover Europe have considered once |”

it realized that the free-flight program was improperly designed? What are some of the potential costs of taking these actions?

d. What factors should be considered in establishing such a program? What role should the accountant have in establishing promotional campaigns?

e. Maytag treated the $50 million as a special expense.
Should it have reported the additional cost as an extraordinary item? Explain.