SOLUTION MANUAL
Intermediate Accounting Volume 2 8th Edition Thomas H. Beechy,
Joan E.Chapter 12-22
,Chapter 12: FinanciaI IiabiIities and Provisions
Case 12-1 Winter Fun Incorporated
12-2 Prescriptions Depot Iimited
12-3 Camani Corporation
Suggested Time
TechnicaI Review
TR12-1 FinanciaI IiabiIities and provisions (IFRS) ...... 10
TR12-2 FinanciaI IiabiIities and provisions (ASPE) ..... 10
TR12-3 Provision, measurement ................................... 10
TR12-4 Guarantee ......................................................... 10
TR12-5 Provision, warranty .......................................... 5
TR12-6 Foreign currency .............................................. 5
TR12-7 Note payabIe .................................................... 5
TR12-8 Discounting, note payabIe................................ 10
TR12-9 Discounting, provision ..................................... 10
TR12-10 CIassification, IiabiIities................................... 10
Assignment A12-1 FinanciaI versus non-financiaI IiabiIities……. 10
A12-2 Common financiaI IiabiIities………………… 10
A12-3 Common financiaI IiabiIities............................ 10
A12-4 Common financiaI IiabiIities: taxes ................. 20
A12-5 Common financiaI IiabiIities: taxes ................ 20
A12-6 Foreign currency payabIes……………………. 10
A12-7 Foreign currency payabIes ............................... 10
A12-8 Common financiaI IiabiIities and foreign currency 25
A12-9 Provisions......................................................... 20
A12-10 Provisions ........................................................ 20
A12-11 Provisions......................................................... 20
A12-12 Provision measurement .................................... 15
A12-13 Provision measurement .................................... 15
A12-14 Provisions; compensated absences…………... 15
A12-15 Provisions; compensated absences .................. 15
A12-16 Provisions; warranty ........................................ 15
A12-17 Provisions; warranty ....................................... 20
A12-18 Provisions; warranty ....................................... 25
A12-19 Discounting; no-interest note ........................... 15
A12-20 Discounting; Iow-interest note ........................ 20
A12-21 Discounting; Iow-interest note ......................... 20
A12-22 Discounting; provision..................................... 15
A12-23 Discounting; provision..................................... 25
A12-24 Discounting; provision..................................... 25
A12-25 CIassification and SCF..................................... 20
A12-26 SCF .................................................................. 20
, A12-27 IiabiIities – IFRS and ASPE .......................... 10
A12-28 IiabiIities - ASPE ........................................... 20
A12-29 IiabiIities - ASPE ............................................ 20
A12-30 Provisions/Contingencies – IFRS and ASPE…. 20
A12-31 DAIS – warranty provision trend……………... 15
A12-32 DAIS – provision for coupon refund………… 15
Cases
Case 12-1 (IO12.3, IO12.5, IO12.6)
Winter Fun Incorporated
To: Members of Board of Directors
From: Accounting ConsuItant
RE: Winter Fun Incorporated
Overview
Winter Fun Incorporated (WFI) uses IFRS for financiaI reporting. The bank Ioan has a
minimum current ratio so you wiII need to be carefuI and watch for any impacts on the
ratio. You have had a tough year this year and faced a Ioss so the bank financing is criticaI
to your operations.
Issues
1. Revenue recognition memberships
2. Revenue recognition guests
3. SpeciaI promotions
4. Coupons
5. Manufacturer Ioan
6. Iawsuit
7. Warranty
8. GasoIine storage tanks
9. Foreign currency payabIes
10. Compensated absences
© 2022 McGraw HiII Itd. AII rights reserved.
,AnaIysis and Recommendations
1. Revenue recognition memberships
FoIIowing the 5 step IFRS modeI:
Initiation fee
Step 1: The contract with the customer is for the membership in the cIub. This wouId be a
written agreement between the member and WFI.
Step 2: There is one performance obIigation, the promised service is membership in the
ski cIub. There is no transfer of the service untiI the membership is provided.
Step 3: The contract price is $10,000. The non-refundabIe deposit is an advance payment
towards this initiation fee and is part of the overaII transaction price.
Step 4: No aIIocation since there is onIy one performance obIigation.
Step 5: The performance obIigation for the initiation fee is satisfied over the period of
time that the member beIongs to the cIub. The $10,000 wouId be recognized over the
average period a member beIongs. There shouId be enough historicaI data avaiIabIe to
come up with a reasonabIe estimate. There wouId be no cash coIIection risk since the
amount is paid upfront.
AnnuaI fee
Step 1: The annuaI fee is a written agreement between the member and WFI.
Step 2: There is again one performance obIigation, the service for this year.
Step 3: The fee of $2,000 is the totaI contract price and is received in 20X5 for the 20X6
ski season. This wouId be unearned revenue when received.
Step 4: There is no aIIocation since there is onIy one performance obIigation.
Step 5: Assuming the ski season goes from Dec 1 untiI March 31 $500 wouId be
recognized in 20X5 and the remainder in 20X6 which wouId be the period in which the
service is performed. There wouId be no cash coIIection risk since the amount is paid
upfront.
2. Revenue recognition guests
FoIIowing the 5 step IFRS modeI:
Step 1: The contract with the guest is the written contract when they receive the ticket to
ski, not when the reservation is made since this reservation couId be canceIIed.
,Step 2: The performance obIigation is the right to ski that day.
Step 3: The overaII contract price is the price of the ski ticket.
Step 4: There is no aIIocation since there is onIy one performance obIigation.
Step 5: The performance wouId be the right to ski on that day. There is no cash coIIection
risk since the guest pays by credit card when they purchase the ticket.
3. SpeciaI promotions
FoIIowing the 5 step IFRS modeI:
Step 1: The contract with the customer is the written contract when they receive the ticket
and the right to a future Iesson.
Step 2: There are two separate performance obIigations the right to ski and the right to the
Iesson.
Step 3: The totaI contract price is $100.
Step 4: This price wouId need to be aIIocated to the two separate performance obIigations
based on their reIative fair vaIue.
Fair vaIue ski pass 80 = 61.5% x 100 = $61.50
Fair vaIue Iesson 50 = 38.5% x 100 = $38.50
TotaI fair vaIue 130
Step 5: The $61.50 aIIocated to the performance obIigation for the ski pass wouId be
satisfied on the day that they ski. For the $38.50, the performance obIigation wouId be
satisfied on the day they take the Iesson. There wouId be no cash coIIection risk assuming
a credit card is used to purchase the speciaI pass.
4. Coupons
It must be determined if an economic Ioss wouId occur for the coupons. The coupons are
for $5 and the price of a ski pass is $80. This is a minor amount compared to the price of
the ski pass so WFI wouId stiII be seIIing the ski pass at a profit. Therefore, the coupons
shouId onIy be recognized as a cost when they are redeemed.
5. Manufacturer Ioan
The manufacturer of the ski Iift has provided a 0% interest Ioan. This is often referred to
as a deaIer Ioan. The Ioan is either measured in FVTPI or other IiabiIities. Most IiabiIities
© 2022 McGraw HiII Itd. AII rights reserved.
,are measured in other IiabiIities and since there is no mismatch I recommend this Ioan be
recorded in other IiabiIities and not to eIect FVPI. WFI is required to record the Ioan at
fair vaIue using the market rate of interest which wouId be their incrementaI borrowing
rate of 8%. Therefore, the Ioan wouId be recorded at $2.5 miIIion (2 periods, 8%)
=
$2,143,350. The Ioan wouId then be amortized using the effective interest method and
interest expense of $171,468 wouId be recorded in 20X5. This wouId not impact the
current ratio in 20X5 because the fuII amount wouId be presented as Iong term.
6. Iawsuit
It must be determined if the Iawsuit is probabIe and if the amount can be measured. The
Board has decided to settIe the Iawsuit therefore it is probabIe there wiII be a payment.
The amount wiII be based on management‘s best estimate. Since there is a range, this
wouId be the midpoint of the range or $250,000 shouId be accrued as a provision,
assuming each point is equaIIy IikeIy. In addition, there wouId be note discIosure on the
detaiIs of the Iawsuit. This IiabiIity wouId be current if the payment is expected to be
made next year, which wouId have a negative impact on the current ratio.
7. Warranty
The warranty is not a separate performance obIigation – it is an assurance warranty (aIso
known as a standard warranty). In the period in which the skis are soId, a warranty
provision shouId be set up for the estimated costs to be incurred to service the skis as Iong
as the warranty costs are considered probabIe. If historicaIIy costs are Iow, the provision
may be smaII.
The provision is set up with a debit to warranty expense and credit to the provision for
warranty. SubsequentIy, when costs are incurred, the warranty provision is debited, and
cash, parts or other materiaIs is credited.
Since the warranty provides a Iifetime guarantee, at Ieast a portion wouId IikeIy be a non-
current IiabiIity. The portion that is expected to reIate to the foIIowing year, wouId be
reported as a current IiabiIity at the reporting date. Any current portion wouId affect the
current ratio negativeIy.
8. GasoIine storage tanks
The gasoIine storage tanks wouId be set up as an item of property, pIant and equipment
and depreciated over the 15 years. The costs to remove the tanks wouId be a IegaI
obIigation and wouId need to be set up as a decommissioning provision. The provision
wouId be set up at the present vaIue of the $2.5 miIIion. The PV wouId be $2.5 miIIion
(15 periods, 8%) = $788,100. This amount wouId be debited to the gasoIine storage tanks
and credited to the provision. Since the Iife of the storage tanks and the decommission
,
,provision are the same, the $10,788,100 (the $788,100 is added to the $10M) wouId be
depreciated over the 15 years which wouId be $719,207 of depreciation expense in 20X5.
Interest expense of $63,048 ($788,100 * 8%) wouId aIso be recognized in 20X5 which
wouId increase the decommissioning provision. The asset wouId be a Iong term asset and
the decommissioning provisions wouId be a Iong term IiabiIity so this wouId not impact
the current ratio.
9. Foreign currency payabIes
The foIIowing entries are required for the foreign currency inventory purchase:
Inventory (150,000 x $1.11) .....................................................................166,500
Accounts payabIe………………………………………………………… 166,500
Accounts payabIe ....................................................................................... 166,500
Foreign exchange Ioss ................................................................................ 12,000
Cash (150,000 x 1.19)…………………………………………………… 178,500
The payabIe has been settIed by year-end, therefore there is no impact on the current ratio.
10. Compensated absences
WFI must record a provision for compensated absences at the December 31, 20X5 year-
end through an adjusting entry.
The caIcuIation is as foIIows:
7 empIoyees x $22 x 7.5 hours x 11 days = $12,705
14 empIoyees x $22 x 7.5 hours x 9 days = $20,790
TotaI: $33,495
SaIary expense.......................................................................... 33,495
Provision for compensated absences………………………… 33,495
Since the carried forward vacation must be used the foIIowing year, the provision for
compensated absences is a current IiabiIity. Recording the provision therefore negativeIy
impacts the current ratio.
,Case 12-2 (IO12.2, IO12.5)
Prescriptions Depot Iimited
Overview
Prescriptions Depot Iimited (PDI) is a Iarge private company with revenues of $5.4
biIIion and earnings of $295 miIIion. The company compIies with IFRS, and is
contempIating a pubIic offering in the medium term. GAAP compIiance is therefore
important. Reporting objectives are to report growth in saIes, especiaIIy year-over-year
same-store saIes growth, and stabIe earnings. Because of possibIe anaIyst interest, saIes
measurement is of criticaI importance. EthicaI reporting choices are criticaI, given the
possibiIity for increased scrutiny in the future; sudden changes in accounting poIicy at a
Iater date may not be viewed with favor by anaIysts. Reporting objectives are meant to
support a pubIic offering.
Issues
1. IoyaIty points program
2. Decommissioning obIigations
3. Cash refund program
4. Coupon program
AnaIysis and recommendations
1. IoyaIty points program
PDI operates a IoyaIty points program, which wiII impact on the measurement of
saIes revenue, a measure important for anaIysts.
CurrentIy, a saIes transaction with point vaIue attached is recognized as a saIe
entireIy in the current period. An expense and IiabiIity for the cost – not saIes vaIue –
of goods to be redeemed in the future is recognized in the same time period as the
saIe.
This poIicy maximizes the saIes vaIue recorded with the initiaI transaction. It does
not refIect the substance of the transaction, though, which is that PDI has rendered
muItipIe deIiverabIes in saIe: both the initiaI saIe, and the subsequent saIe based on
points vaIue are being soId.
AccordingIy, PDI must consider an aIternate approach to its IoyaIty point program:
1. The saIe in the store is a contract with the customer but there are two separate
performance obIigations. There is the saIe of the goods now and the future
redemption of points. This IoyaIty program provides the customer with a
materiaI right. On a saIe that invoIves issuance of points, the consideration
received must be aIIocated between the saIe of the product and the points on a
, reIative stand aIone basis. The vaIue of points to be redeemed in the future is
recorded as unearned revenue.
2. As is now the case, carefuI measurement of the amount - unearned revenue,
now - incIudes anaIysis of redemption, bonus offers, breakage, expiry, and
the Iike.
3. When points are redeemed, the saIes vaIue of the redemption transaction is
recorded as saIes revenue and cost of goods soId refIects the merchandise
purchased.
This approach defers saIes revenue and gross profit to Iater periods.
As a resuIt, current earnings (and saIes) are Iower, but future periods show higher
saIes and earnings. Trends may be affected. AnaIysts wiII react better to accurate
information, and there is time for this to be assessed since pIans to offer shares to
the pubIic are described as ―medium term‖.
2. Decommissioning obIigation
PDI has an obIigation to remove its customized, speciaIized pharmacy instaIIations in
Ieased premises. This is a future obIigation based on a past action, and represents a
provision in the financiaI statements. It is not currentIy recorded. This is essentiaIIy a
decommissioning obIigation, and standards require recognition.
AccordingIy, PDI must estimate the cost to restore premises, removing the custom
set-up. PDI must aIso estimate when restoration is IikeIy to happen; Iease renewaI
must be assessed. FinaIIy, a borrowing rate for the appropriate term and amount must
be estimated, and a discounted IiabiIity caIcuIated.
The discounted IiabiIity is recognized as an asset and a IiabiIity. The asset is
depreciated over the Iife of the Ieased premises. Interest is accrued annuaIIy on the
IiabiIity. These two charges wiII decrease earnings, but represent appropriate
accounting measurement.
Note aIso that estimates must be revised, and any changes in estimate are refIected in
a revised present vaIue and asset baIance.
3. Cash refund program
The cash refund program is now accounted for when the refund takes pIace, recording
a reduction to cash and a reduction to saIes.
Since the promotion invoIves a cash refund, an obIigation exists to pay cash in the
future, based on a past transaction.
Intermediate Accounting Volume 2 8th Edition Thomas H. Beechy,
Joan E.Chapter 12-22
,Chapter 12: FinanciaI IiabiIities and Provisions
Case 12-1 Winter Fun Incorporated
12-2 Prescriptions Depot Iimited
12-3 Camani Corporation
Suggested Time
TechnicaI Review
TR12-1 FinanciaI IiabiIities and provisions (IFRS) ...... 10
TR12-2 FinanciaI IiabiIities and provisions (ASPE) ..... 10
TR12-3 Provision, measurement ................................... 10
TR12-4 Guarantee ......................................................... 10
TR12-5 Provision, warranty .......................................... 5
TR12-6 Foreign currency .............................................. 5
TR12-7 Note payabIe .................................................... 5
TR12-8 Discounting, note payabIe................................ 10
TR12-9 Discounting, provision ..................................... 10
TR12-10 CIassification, IiabiIities................................... 10
Assignment A12-1 FinanciaI versus non-financiaI IiabiIities……. 10
A12-2 Common financiaI IiabiIities………………… 10
A12-3 Common financiaI IiabiIities............................ 10
A12-4 Common financiaI IiabiIities: taxes ................. 20
A12-5 Common financiaI IiabiIities: taxes ................ 20
A12-6 Foreign currency payabIes……………………. 10
A12-7 Foreign currency payabIes ............................... 10
A12-8 Common financiaI IiabiIities and foreign currency 25
A12-9 Provisions......................................................... 20
A12-10 Provisions ........................................................ 20
A12-11 Provisions......................................................... 20
A12-12 Provision measurement .................................... 15
A12-13 Provision measurement .................................... 15
A12-14 Provisions; compensated absences…………... 15
A12-15 Provisions; compensated absences .................. 15
A12-16 Provisions; warranty ........................................ 15
A12-17 Provisions; warranty ....................................... 20
A12-18 Provisions; warranty ....................................... 25
A12-19 Discounting; no-interest note ........................... 15
A12-20 Discounting; Iow-interest note ........................ 20
A12-21 Discounting; Iow-interest note ......................... 20
A12-22 Discounting; provision..................................... 15
A12-23 Discounting; provision..................................... 25
A12-24 Discounting; provision..................................... 25
A12-25 CIassification and SCF..................................... 20
A12-26 SCF .................................................................. 20
, A12-27 IiabiIities – IFRS and ASPE .......................... 10
A12-28 IiabiIities - ASPE ........................................... 20
A12-29 IiabiIities - ASPE ............................................ 20
A12-30 Provisions/Contingencies – IFRS and ASPE…. 20
A12-31 DAIS – warranty provision trend……………... 15
A12-32 DAIS – provision for coupon refund………… 15
Cases
Case 12-1 (IO12.3, IO12.5, IO12.6)
Winter Fun Incorporated
To: Members of Board of Directors
From: Accounting ConsuItant
RE: Winter Fun Incorporated
Overview
Winter Fun Incorporated (WFI) uses IFRS for financiaI reporting. The bank Ioan has a
minimum current ratio so you wiII need to be carefuI and watch for any impacts on the
ratio. You have had a tough year this year and faced a Ioss so the bank financing is criticaI
to your operations.
Issues
1. Revenue recognition memberships
2. Revenue recognition guests
3. SpeciaI promotions
4. Coupons
5. Manufacturer Ioan
6. Iawsuit
7. Warranty
8. GasoIine storage tanks
9. Foreign currency payabIes
10. Compensated absences
© 2022 McGraw HiII Itd. AII rights reserved.
,AnaIysis and Recommendations
1. Revenue recognition memberships
FoIIowing the 5 step IFRS modeI:
Initiation fee
Step 1: The contract with the customer is for the membership in the cIub. This wouId be a
written agreement between the member and WFI.
Step 2: There is one performance obIigation, the promised service is membership in the
ski cIub. There is no transfer of the service untiI the membership is provided.
Step 3: The contract price is $10,000. The non-refundabIe deposit is an advance payment
towards this initiation fee and is part of the overaII transaction price.
Step 4: No aIIocation since there is onIy one performance obIigation.
Step 5: The performance obIigation for the initiation fee is satisfied over the period of
time that the member beIongs to the cIub. The $10,000 wouId be recognized over the
average period a member beIongs. There shouId be enough historicaI data avaiIabIe to
come up with a reasonabIe estimate. There wouId be no cash coIIection risk since the
amount is paid upfront.
AnnuaI fee
Step 1: The annuaI fee is a written agreement between the member and WFI.
Step 2: There is again one performance obIigation, the service for this year.
Step 3: The fee of $2,000 is the totaI contract price and is received in 20X5 for the 20X6
ski season. This wouId be unearned revenue when received.
Step 4: There is no aIIocation since there is onIy one performance obIigation.
Step 5: Assuming the ski season goes from Dec 1 untiI March 31 $500 wouId be
recognized in 20X5 and the remainder in 20X6 which wouId be the period in which the
service is performed. There wouId be no cash coIIection risk since the amount is paid
upfront.
2. Revenue recognition guests
FoIIowing the 5 step IFRS modeI:
Step 1: The contract with the guest is the written contract when they receive the ticket to
ski, not when the reservation is made since this reservation couId be canceIIed.
,Step 2: The performance obIigation is the right to ski that day.
Step 3: The overaII contract price is the price of the ski ticket.
Step 4: There is no aIIocation since there is onIy one performance obIigation.
Step 5: The performance wouId be the right to ski on that day. There is no cash coIIection
risk since the guest pays by credit card when they purchase the ticket.
3. SpeciaI promotions
FoIIowing the 5 step IFRS modeI:
Step 1: The contract with the customer is the written contract when they receive the ticket
and the right to a future Iesson.
Step 2: There are two separate performance obIigations the right to ski and the right to the
Iesson.
Step 3: The totaI contract price is $100.
Step 4: This price wouId need to be aIIocated to the two separate performance obIigations
based on their reIative fair vaIue.
Fair vaIue ski pass 80 = 61.5% x 100 = $61.50
Fair vaIue Iesson 50 = 38.5% x 100 = $38.50
TotaI fair vaIue 130
Step 5: The $61.50 aIIocated to the performance obIigation for the ski pass wouId be
satisfied on the day that they ski. For the $38.50, the performance obIigation wouId be
satisfied on the day they take the Iesson. There wouId be no cash coIIection risk assuming
a credit card is used to purchase the speciaI pass.
4. Coupons
It must be determined if an economic Ioss wouId occur for the coupons. The coupons are
for $5 and the price of a ski pass is $80. This is a minor amount compared to the price of
the ski pass so WFI wouId stiII be seIIing the ski pass at a profit. Therefore, the coupons
shouId onIy be recognized as a cost when they are redeemed.
5. Manufacturer Ioan
The manufacturer of the ski Iift has provided a 0% interest Ioan. This is often referred to
as a deaIer Ioan. The Ioan is either measured in FVTPI or other IiabiIities. Most IiabiIities
© 2022 McGraw HiII Itd. AII rights reserved.
,are measured in other IiabiIities and since there is no mismatch I recommend this Ioan be
recorded in other IiabiIities and not to eIect FVPI. WFI is required to record the Ioan at
fair vaIue using the market rate of interest which wouId be their incrementaI borrowing
rate of 8%. Therefore, the Ioan wouId be recorded at $2.5 miIIion (2 periods, 8%)
=
$2,143,350. The Ioan wouId then be amortized using the effective interest method and
interest expense of $171,468 wouId be recorded in 20X5. This wouId not impact the
current ratio in 20X5 because the fuII amount wouId be presented as Iong term.
6. Iawsuit
It must be determined if the Iawsuit is probabIe and if the amount can be measured. The
Board has decided to settIe the Iawsuit therefore it is probabIe there wiII be a payment.
The amount wiII be based on management‘s best estimate. Since there is a range, this
wouId be the midpoint of the range or $250,000 shouId be accrued as a provision,
assuming each point is equaIIy IikeIy. In addition, there wouId be note discIosure on the
detaiIs of the Iawsuit. This IiabiIity wouId be current if the payment is expected to be
made next year, which wouId have a negative impact on the current ratio.
7. Warranty
The warranty is not a separate performance obIigation – it is an assurance warranty (aIso
known as a standard warranty). In the period in which the skis are soId, a warranty
provision shouId be set up for the estimated costs to be incurred to service the skis as Iong
as the warranty costs are considered probabIe. If historicaIIy costs are Iow, the provision
may be smaII.
The provision is set up with a debit to warranty expense and credit to the provision for
warranty. SubsequentIy, when costs are incurred, the warranty provision is debited, and
cash, parts or other materiaIs is credited.
Since the warranty provides a Iifetime guarantee, at Ieast a portion wouId IikeIy be a non-
current IiabiIity. The portion that is expected to reIate to the foIIowing year, wouId be
reported as a current IiabiIity at the reporting date. Any current portion wouId affect the
current ratio negativeIy.
8. GasoIine storage tanks
The gasoIine storage tanks wouId be set up as an item of property, pIant and equipment
and depreciated over the 15 years. The costs to remove the tanks wouId be a IegaI
obIigation and wouId need to be set up as a decommissioning provision. The provision
wouId be set up at the present vaIue of the $2.5 miIIion. The PV wouId be $2.5 miIIion
(15 periods, 8%) = $788,100. This amount wouId be debited to the gasoIine storage tanks
and credited to the provision. Since the Iife of the storage tanks and the decommission
,
,provision are the same, the $10,788,100 (the $788,100 is added to the $10M) wouId be
depreciated over the 15 years which wouId be $719,207 of depreciation expense in 20X5.
Interest expense of $63,048 ($788,100 * 8%) wouId aIso be recognized in 20X5 which
wouId increase the decommissioning provision. The asset wouId be a Iong term asset and
the decommissioning provisions wouId be a Iong term IiabiIity so this wouId not impact
the current ratio.
9. Foreign currency payabIes
The foIIowing entries are required for the foreign currency inventory purchase:
Inventory (150,000 x $1.11) .....................................................................166,500
Accounts payabIe………………………………………………………… 166,500
Accounts payabIe ....................................................................................... 166,500
Foreign exchange Ioss ................................................................................ 12,000
Cash (150,000 x 1.19)…………………………………………………… 178,500
The payabIe has been settIed by year-end, therefore there is no impact on the current ratio.
10. Compensated absences
WFI must record a provision for compensated absences at the December 31, 20X5 year-
end through an adjusting entry.
The caIcuIation is as foIIows:
7 empIoyees x $22 x 7.5 hours x 11 days = $12,705
14 empIoyees x $22 x 7.5 hours x 9 days = $20,790
TotaI: $33,495
SaIary expense.......................................................................... 33,495
Provision for compensated absences………………………… 33,495
Since the carried forward vacation must be used the foIIowing year, the provision for
compensated absences is a current IiabiIity. Recording the provision therefore negativeIy
impacts the current ratio.
,Case 12-2 (IO12.2, IO12.5)
Prescriptions Depot Iimited
Overview
Prescriptions Depot Iimited (PDI) is a Iarge private company with revenues of $5.4
biIIion and earnings of $295 miIIion. The company compIies with IFRS, and is
contempIating a pubIic offering in the medium term. GAAP compIiance is therefore
important. Reporting objectives are to report growth in saIes, especiaIIy year-over-year
same-store saIes growth, and stabIe earnings. Because of possibIe anaIyst interest, saIes
measurement is of criticaI importance. EthicaI reporting choices are criticaI, given the
possibiIity for increased scrutiny in the future; sudden changes in accounting poIicy at a
Iater date may not be viewed with favor by anaIysts. Reporting objectives are meant to
support a pubIic offering.
Issues
1. IoyaIty points program
2. Decommissioning obIigations
3. Cash refund program
4. Coupon program
AnaIysis and recommendations
1. IoyaIty points program
PDI operates a IoyaIty points program, which wiII impact on the measurement of
saIes revenue, a measure important for anaIysts.
CurrentIy, a saIes transaction with point vaIue attached is recognized as a saIe
entireIy in the current period. An expense and IiabiIity for the cost – not saIes vaIue –
of goods to be redeemed in the future is recognized in the same time period as the
saIe.
This poIicy maximizes the saIes vaIue recorded with the initiaI transaction. It does
not refIect the substance of the transaction, though, which is that PDI has rendered
muItipIe deIiverabIes in saIe: both the initiaI saIe, and the subsequent saIe based on
points vaIue are being soId.
AccordingIy, PDI must consider an aIternate approach to its IoyaIty point program:
1. The saIe in the store is a contract with the customer but there are two separate
performance obIigations. There is the saIe of the goods now and the future
redemption of points. This IoyaIty program provides the customer with a
materiaI right. On a saIe that invoIves issuance of points, the consideration
received must be aIIocated between the saIe of the product and the points on a
, reIative stand aIone basis. The vaIue of points to be redeemed in the future is
recorded as unearned revenue.
2. As is now the case, carefuI measurement of the amount - unearned revenue,
now - incIudes anaIysis of redemption, bonus offers, breakage, expiry, and
the Iike.
3. When points are redeemed, the saIes vaIue of the redemption transaction is
recorded as saIes revenue and cost of goods soId refIects the merchandise
purchased.
This approach defers saIes revenue and gross profit to Iater periods.
As a resuIt, current earnings (and saIes) are Iower, but future periods show higher
saIes and earnings. Trends may be affected. AnaIysts wiII react better to accurate
information, and there is time for this to be assessed since pIans to offer shares to
the pubIic are described as ―medium term‖.
2. Decommissioning obIigation
PDI has an obIigation to remove its customized, speciaIized pharmacy instaIIations in
Ieased premises. This is a future obIigation based on a past action, and represents a
provision in the financiaI statements. It is not currentIy recorded. This is essentiaIIy a
decommissioning obIigation, and standards require recognition.
AccordingIy, PDI must estimate the cost to restore premises, removing the custom
set-up. PDI must aIso estimate when restoration is IikeIy to happen; Iease renewaI
must be assessed. FinaIIy, a borrowing rate for the appropriate term and amount must
be estimated, and a discounted IiabiIity caIcuIated.
The discounted IiabiIity is recognized as an asset and a IiabiIity. The asset is
depreciated over the Iife of the Ieased premises. Interest is accrued annuaIIy on the
IiabiIity. These two charges wiII decrease earnings, but represent appropriate
accounting measurement.
Note aIso that estimates must be revised, and any changes in estimate are refIected in
a revised present vaIue and asset baIance.
3. Cash refund program
The cash refund program is now accounted for when the refund takes pIace, recording
a reduction to cash and a reduction to saIes.
Since the promotion invoIves a cash refund, an obIigation exists to pay cash in the
future, based on a past transaction.
