1.Assess the Company's current accounting policy for each type of gift card.Determine whether the policy is consistent with the revenue standard.If the policy is not, what would be the correct accounting? You should support your analyses and conclusions by citing the applicable section(s) of the FASB Codification.

2.The Company has already made the decision to transition to the new revenue standard using the modified retrospective approach.Compute the amount of the cumulative adjustment to the opening balance of retained earnings for 2019 and the adjustments (if any) to the draft 2019 financial statements.You may ignore any income tax effects.

3.Discuss any other impact implementations the new revenue standard may have beyond the financial statements.

A00 675 ABC Stores, Inc. Financial Reporting of Gift Cards 2020 ABC Stores, Inc. (ABC or the Company) is an operator of discount general merchandise stores. The Company's stores generally serve |ow-. middle-, and fixed-income families that reside in small to medium-sized towns. Founded in 1969 in North Carolina with a single store, ABC has achieved signicant brand recognition in its target markets and had grown to over 400 company-owned stores located across the southeast. The Company is privately owned and does not meet the FASB's denition of a public business entity. The Company has considered going public at some point in the future so is sensitive to its earnings performance and EPS. The Company's strategy consists of meeting the general merchandise needs of its target customers by offering (1) a wider variety of quality merchandise and a more attractive price-to-value relationship than the smaller varietyldollar stores, (2) a shopper- friendly format that is more convenient than larger-sized discount merchandise stores, and (3) customer service, which exceeds that of both. ABC guarantees quality of all the products it sells and also offers extended service contracts on behalf of third parties on higher-priced items such as appliances and electronic products. Strategy and Performance Foreseeing a weakening retail environment, ABC started implementing a new strategy in the second half of scal 2017 focusing on enhancing its brand, improving operational performance. eliminating underperforming assets. and streamlining cost structure. This has enabled ABC to deliver higher sales and earnings in scal 2019 at a time when many other retailers experienced a decline The preliminary results for scal year 2019 (the Company's scal year is March 1 thru the end of February) indicate. however. that the Company would not meet its earnings estimate. Tough credit markets in 2019 have made additional borrowings difcult and expensive for ABC. The senior management of the Company is particularly concerned that a debt covenant with one of its crucial lenders is likely to be violated if ABC cannot maintain a current ratio of 1.40 or higher. If a violation occurs, the creditor would have the right to accelerate maturity of the debt or seize the collateralized assets. Executive Compensation Impressed with the past performance of its senior management. the Board of Directors of ABC approved generous executive compensation packages (consisting of base salary, annual bonuses, and long-term incentives) to its senior management. An annual bonus of up to 100 percent of base salary is awarded based on the Board's evaluation of senior management's performance. While 40 percent of the bonus is based on the Board's subjective evaluation, the remaining amount (60 percent) is based on meeting or exceeding specied targets. For the scal year 2019, these targets are (1) annual sales growth of 12 percent or higher, (2) annual gross prot of 24 percent or higher, and (3) earnings per share (EPS) of $32.05 or higher. Senior management is entitled to a bonus of 20 percent of base salary for each target achieved. Gift Cards Initiative Among the several factors that have contributed to ABC's success in recent years are its three gift card programs. Presented below is pertinent information relating to the Company's: a) sales of gift cards of other retailers, b) issuance of ABC's restricted gift cards during a special Thanksgiving promotion. and 0) sales of it ABC gift cards. Gift Cards of Other Retailers In scal 2019, ABC began selling gift cards of several other regional and national retailers. ABC receives a commission of 15 percent of the value of the gift card when the card is swiped through a POS (Point of Sale) terminal of ABC. The sale of other retailers' gift cards by ABC is non-refundable. and the cards can only be redeemed at the sales channels of the respective retailers. In scal 2019, ABC recorded $50 million as sales of gift cards of other retailers and $42.5 million as the cost of goods sold. These amounts are included in the Company's 2019 income statement as sales and cost of goods sold, respectively. Gift Cards Issued during the Special Thanksgiving Promotion As a special promotion around Thanksgiving in 2019. the Company announced that for one week, each purchaser of a computer-notebook and monitor package at the regular price of $3,000 would receive a $400 ABC gift card. These special gift cards were restricted to future ABC purchases and would expire after six months. The promotion resulted in the Company issuing $20 million worth of gift cards. These were recorded as a reduction in sales and as a liability. The $18 million of gift cards redeemed by customers before the end of scal year 2019 were recognized as sales and a decrease in the liability recorded earlier. ABC's management estimates that it is unlikely that customers will redeem the remaining gift card amount ($2 million). During the process of its year-end closing, management proposed that this amount be recognized as sales and a decrease in the liability recorded earlier in 2019. ABC does not have any prior experience with running a special promotion like this and is unable to determine if and when the remaining cards will be redeemed before their expiration date ABC Gift Cards The Company started selling ABC gift cards in its retail stores in 2010 and on the web in 2012. The company's gift cards have been recognized by Consumer Affairs as a \"top pick" for not having deceptive features such as expiration dates. dormancy fees, and post-purchase fees. The amount of the \"gift" value is loaded and stored on the host database by swiping a magnetic-stripped card through a POS terminal. Customers can add to outstanding amounts on their existing gift cards in the Company stores or on its website. Customers can choose from a variety of gift card designs suitable for dierent occasions. ABC also allows customers to upload photographs to create their own cards. The gift cards may be used multiple times to pay for merchandise or services. Over one-half of the annual sales of gift cards occur around the Christmas holiday season. Most customers use the gift cards to make purchases in January when clearance sales are more common. ABC records a gift card liability upon the sale of gift cards. At the time of redemption, it recognizes sales revenue in the amount of redemption and reduces the gift card liability. To date, ABC has not recognized any income for unredeemed gift cards. Instead, the cumulative amount of unredeemed gift cards is included in \"other current liabilities" in the Company's statement of nancial position. A footnote in the nancial statements of fiscal 2017 stated: The Company has not recognized any revenue from gift card \"breakage" since the inception of the program in 2010 and does not expect to record any \"breakage" revenue until there is certainty regarding our ability to retain such amounts in light of current consumer protection and state escheatment (i.e., unclaimed property) laws. In scal 2019, after a review of past redemption patterns and relevant escheatment laws, the management of ABC concluded that it could estimate the likely non- redemption 36 months after the sale of the card. The escheatment rules in the state of North Carolina do not require retailers headquartered in North Carolina to remit the value of unredeemed gift cards to the state. regardless of which state the gift cards are sold in. Past experience with redemptions indicates that typically 75 percent of the value of gift cards purchased is redeemed by customers in the scal year in which the gift cards were purchased. Another 12 percent is redeemed in the scal year after the year of purchase, and 3 percent in the following year. On average, 10 percent of the value of the gift cards is never redeemed. The most common reasons for non-redemption include customers losing or misplacing the gift cards or forgetting to redeem the remaining value. Although it is possible to replace the remaining value on a lost, stolen. or damaged card by presenting the original purchase receipt, most customers do not. Presented below are the Company's yearly and cumulative sales of the ABC gift cards: ABC Gift Card Sales Amounts in Thousands ABC Gift Card Cumulative Fiscal Year Sales Sales Total $30,484 $10,436 40,920 11,897 52,817 13,562 66,379 15,461 81,840 17,625 99,465 20,093 119,558 Taxation of Gift Card Breakage on ABC's Gift Cards ABC follows the accrual method of accounting for tax purposes. Although advance payments (such as interest and rent receipts) are generally taxed in the year of receipt. Reg. 1.451-5(c} species exceptions for inventoried goods. If a taxpayer receives an advance payment in a taxable year with respect to an agreement (such as a gift card), then all payments received that are not previously included in income in accordance with the taxpayer's accrual method of accounting shall be included in the taxable income of the second taxable year following the year in which the payments were received. For instance. if gift cards of $100 are sold in year 1. and redemptions in years 1, 2, 3, and 4 are $60, $15, $13, and $4, respectively, the taxable income from gift cards would be $60 in year 1 and $15 in year 2, the same as the income recognized under the accrual method. In year 3. which is the second year following the year in which the gift cards were sold, all of the remaining income of $25 would be taxable. Financial Statements ABC's draft nancial statements for the 2019 scal year are provided in Exhibit 1. The Company's unredeemed gift card liabilities, unearned revenues, and deferred tax liabilities are included in other current liabilities. and deferred tax assets are included in other current assets in the statement of financial position. The nancial statements are not nal and do not reect management's contemplated accounting policy changes. The Company recognizes revenue when the customer takes possession of the merchandise. The Company will be implementing the new revenue standard as reected in the FASB's Codication (Topic 606). Although ABC uses separate accounts (such as gross sales, sales discounts, sales returns. and sales allowances) to record individual transactions, net sales reported in the statement of operations represent the aggregate sum of those accounts. The controller is condent the Company's accounting policies related to its basic sales transactions are consistent with the new revenue standard but is uncertain about the revenue recognition related to the gift cards. Required: 1. Assess the Company's current accounting policy for each type of gift card. Determine whether the policy is consistent with the revenue standard. If the policy is not, what would be the correct accounting? You should support your analyses and conclusions by citing the applicable section(s) of the FASB Codication. 2. The Company has already made the decision to transition to the new revenue standard using the modied retrospective approach. Compute the amount of the cumulative adjustment to the opening balance of retained earnings for 2019 and the adjustments (if any) to the draft 2019 nancial statements. You may ignore any income tax effects. 3. Discuss any other impact implementations the new revenue standard may have beyond the nancial statements. ABC Stores, Inc Balance Sheet February 28, 2018 and 2019 (Amounts in thousands) 2019 Current Assets Cash and cash equivalents Receivables Merchandise inventories Other current assets Total current assets Property and Equipment Land and buildings Leasehold improvements Fixtures and equipment Less: accumulated depreciation Other Assets Total assets Current Liabilities Accounts payable Accrued income taxes Other current liabilities Total current liabilities Long Term Debt Stockholders' Equity Common stock {$1 par value) Additional paid in capital Retained earnings Total stockholders' equity Total liabilities and stockholders' equity $44,865 17,129 146,890 21 ,091 229,975 36,098 64,802 109,980 210,880 71 ,822 139,058 47,736 m $127,940 15,786 29,132 172,955 86,738 1,248 13,417 142,509 127,174 $516110 2018 $37,596 57,658 125,1 12 37,814 258,180 21,996 48,048 89,388 159,432 61,339 98,093 23,868 $3391.41 $1 13,096 17,737 43,449 174,292 65,983 1,248 13,416 125,212 139,876 5.3.6.0141 Net sales Cost of goods sold Gross profit Selling, general and m expenses Operating income Interest expense Other (loss) income Income before income taxes Income tax expense Net income Earnings per share ABC Stores, Inc. Income Statement For the Periods Ending February 28, 2017, 2018, and 2019 (Amounts in thousands, except earnings per share) M 51,243,713 950,332 297,335 221,332 75,004 1,934 m 74,350 29,940 55.45319 535.99 M 51,121,141 347,543 273,593 m 52,333 24,935 531.403 $29.97 M $993,034 750 405 232,523 131 953 50,570 942 @ 50,503 20 243 $393315 $24.33