Question
IS THIS CORRECT? PLEASE PROVIDE ME SUGGESTIONS ON THE ALTERNATIVES AND RECOMMENDATIONS BASED ON ASPE - UNSURE IF I AM CORRECT Issue - 3 The
IS THIS CORRECT? PLEASE PROVIDE ME SUGGESTIONS ON THE ALTERNATIVES AND RECOMMENDATIONS BASED ON ASPE - UNSURE IF I AM CORRECT
Issue - 3
The issue is that SAC has elaborated a marketing initiative in which a free for-life gym membership will be given to the selected client from a random draw if this does more push ups than Harry. Unknown effect of the next year's future competition and awarded prize ($50 x 12 months = $600 a year) in the financial statements and whether or not it should be recorded at the year end Dec 31, 2019 financial statements. Do the free membership challenge meet the definition of a liability, if so, should it be recognized?
Implication
Is there a liability that should be recorded or not? What will be the implication in the financial statements and debt to equity ratio if the free membership challenge meets the criteria of a liability.
Analysis
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ASPE does not have specific measurement standards for non-financial liabilities
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It is an offer to customers with evidence of having use a particular service after its purchase
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It is a marketing initiative to increase sales
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Total obligations at period end are recognized as a liability, estimated cost is expensed in the current period
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The matching principle will be violated without properly accounting for the free membership earned by the customer if this wins the challenge (when the event occurs)
-
Recording a liability can affect the D/E ratio for the Dec 31, 2019 year end
As per ASPE a liability is an obligation that arises from past transactions or events, which may result in a transfer of assets or provision of services.
Liabilities have three essential characteristics:
1.They embody a duty or responsibility to others: Yes, Harry has automatically entered clients into the draw every time they enter the gym with the purpose of earning a future life-free membership
2.The entity has little or no discretion to avoid the duty: Yes, Harry is sure about the draw, this will occur on Feb 5 of the following fiscal year, being the competition on the 25th of that month. The award of the life-time membership has a likelihood of not occurring if Harry wins the competition.
3.The transaction or event that obliges the entity has already occurred: No, the draw and competition has not taken place, this event hasn't occurred in the past.
Alternative(s)
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Record a liability (e.g. membership pass) when the event occurs (Harry awards the membership), based on the matching purpose principle. The possibility for a customer to win the competition after the draw is very unlikely considering Harry's physique.
-
Record liability and match expense to the current period since there is a possibility of Harry having to provide the life-time free membership. Moreover, Harry has the event organized and pleaded that the winner of the competition will be awarded the promised price.
Recommendation
Alternative 1 - There is no need to record a liability at the moment since there is a possibility that the transaction does not occur in the coming year, also there is no record of it occurring previously. In order for the free-lifetime membership to be awarded, the person needs to compete against Harry. Harry's physique is a significant advantage against the person he is competing with which provides a lot of uncertainty whether or not someone will be able to get awarded the price.
In case that the customer does win and receives the prize of $600 a year (12 months x $50), the price can be expensed the following way per year for the free membership.
Feb 25, 2020
Account | Dr | Cr |
Accounts receivable | 600 |
|
Membership Pass |
| 600 |
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