Southbench Athletic Club (SAC) is a new athletic facility, located in Saskatoon, Saskatchewan. SAC is owned and operated by Harry Muscle, a former Olympic gold medalist in weightlifting. Harry decided to make his passion his business by opening open a local gym. SAC has the following mission statement:

“SAC provides the residents of Saskatoon the opportunity to live a healthier, happier, and longer life by providing affordable access to athletic equipment, aerobic classes, and specialized dieticians.”

Harry borrowed $10 million from the bank in order to finance the required start-up investments in working capital and capital assets. Harry invested $2 million of his own money (that he earned through his career as a weightlifter and professional wrestler). The bank does not want the debt-to-equity ratio to exceed 5:1.

The first year of business has been a bit a rocky, as Harry’s expertise is in weight training, as opposed to running a business. However, SAC was able to attract 5,000 people to purchase full memberships.

It was difficult to attract new members during the first few months of operations. In order to attract more members, Harry implemented the following creative marketing initiatives during the middle of the year:

Muscle Points—SAC offers its members 1 point per visit to the gym (maximum of 1 point per day). Muscle Points can be redeemed for free passes for a guest or for a free protein drink.

Initial Fee Return Guarantee—For three months, SAC provided new members with a guarantee period whereby their initial membership fee could be returned if they decide to discontinue their membership within the first year.

Free Membership Challenge—Members are entered into a draw every time they access the gym, and provided with a chance to win free membership fees for life.

Harry has come to you, Badami and Lusamba LLP, for assistance regarding the preparation of the December 31 year-end financial statements in accordance with ASPE. Harry knows how much cash came in from memberships, but is unsure about how much revenue should be recognized. In addition, Harry needs help understanding how the marketing initiatives impact the financial statement. Additional details on the marketing initiatives can be found in Exhibit I, which outlines your most recent discussion with Harry.

Required:

Prepare a report that addresses Harry’s concerns. The partner would like you to do a good job on this engagement as it may lead to more work, and the annual year-end audit. Therefore, the partner has asked you to provide analysis and recommendations for all issues. Also, the partner has asked you to prepare any journal entries to record your recommended accounting treatments.

Exhibit I

Discussion with Harry Muscle

Memberships require a non-refundable $500 initiation fee, followed by a monthly fee of $50. The monthly fee must be paid at the beginning of each month. The following is a monthly breakdown of the new memberships.

SAC offered new members an initial fee return guarantee during the months of July, August, and September. The program was well received and resulted in significant increases in membership. Harry believes the program is so successful because it provides people with a risk-free opportunity to see what SAC has to offer. Harry is confident that once a member has a chance to work out at the gym, and take advantage of all it has to offer, no one will discontinue their membership. As of December 31, not a single person has taken advantage of the initial fee return guarantee. Revenue has been recorded on a cash basis by Harry.

The Muscle Points can be redeemed as follows:

A total of 10 Muscle Points can be redeemed for a free pass for a guest. With a free pass, a member can bring a guest into the gym to use all of the facilities for free. The only condition is that a free-pass guest cannot partake in any aerobic classes if they are full (i.e., they cannot bump out a paying customer). Anyone can purchase a day pass to SAC for $5, which will entitle them to full access to the gym, including all classes.

A total of 15 Muscle Points can be redeemed for a free protein shake. The shake can be purchased from SAC for $6.50. It costs SAC a total of $2.50 including all overhead allocations, to prepare the shake.

During the year, a total of 30,255 Muscle Points were issued. Members took favorably to this promotion; the Points were redeemed for 60 free guest passes and 75 free protein shakes. Industry standards suggest that a total of 20% of all Points will not be redeemed. The only journal entries recorded in regards to the Muscle Points was a debit to cost of goods sold and credit to inventory for the protein shakes.

Every time a member swipes their membership card to access the gym, they are electronically entered into a random draw. The winner of the draw will then have a chance to win a free membership for life. In order to win the challenge, the member must do more push-ups than Harry. The draw will take place on February 5 of the following fiscal year, and the push-up challenge will take place on February 25.

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