P4 As Easy as ABC INTRODUCTION ABC Warehouse operates a chai

P4. As Easy as ABC INTRODUCTION ABC Warehouse operates a chain of 35 discount retail appliance and electronics stores in Michigan, Ohio, and Indiana. The firm is privately held and began operations with a single Michigan location in 1964. ABC\'s operations are similar to national retailer BestBuy, but on a smaller scale ABC offered a special promotion to its customers, promising a 50 percent cash rebate ten years after the date of purchase. The case asks you to consider the economics and judgment made by management in deciding to offer this promotion. You are then asked to decide how ABC should account for sales revenue and the promised rebates under this promotion. The case requires you to consider the role of estimation in accounting and financial reporting, including appropriate consideration of the potential contingent liability THE ABC WAREHOUSE REBATE OFFER ABC Warehouse advertised the following special offer to customers A 50 percent cash rebate on your purchases in ten years The offer was subiect to several conditions: .The application form and a copy of the store receipt must be mailed within 21 days of . The rebate certificate must be available ten years from today and must be submitted . Customers must survive; rebates are not transferable. Customers are protected even if ABC goes out of business or is sold. ABC will purchase This offer applies to all purchases purchase. Upon receipt, ABC would issue a rebate certificate within 90 days of the ten-year maturity date. Customers cannot misplace any of the documents. insurance to guarantee payment of the rebates in the (unlikely) event they go bankrupt. Assuming all of the conditions were met, ABC would send a 50 percent cash rebate after ten years The offer received attention in the local and regional business press. The offer appeared unique in the U.S., but the reporter noted that such promotions had been successfully employed in the past in both Canada and Europe. The offer was made near the end of ABC\'s fiscal year (Year 0). Assume that the promotion ran for two weeks and generated sales of S5 million. For simplicity, you may assume that all sales were cash sales. You may also assume the ABC\'s gross margin is 20 percent of sales. Reminder: I don\'t need a Cash amount (balance) on the B/S

Solution

Question 1.

As the same promotion in past in Canada and Europe were a great success the ABC company want to follow the same and as there is no immediate liability, It can also be maintained over a period as provisional and can easily pay the cash rebate in future

The customer will take an advantage as the products are an electronic type usually have a covered warranty and can be used over a period of some years. Hence the customer will take a advantage.

Question 2.

Recording the sales: The company should as usually record and recognize the revenue of 5 million sales in the current year with other sales, and in case of the rebate offer the company the amount of 2.5 million (i.e. the 50% of 5 million) should be apportioned over the period of 10 years including this year to a particular reserve from the earned profits.

It means the company should maintain the provision for the repayment of the rebate of 2.5 million for 10 years, which means in the current year we should appropriate a provision of 0.25 (2.5 million/ 10 years) million as the provision and the same reserve shall be maintained for the upcoming 9 years

The following are to be followed in case of issuing the rebate offer:

Question 3

Accounting entries:

In the case of sales

Sales account Dr. XXXX ------

To Customer account ------ XXXX

In the case of provision for rebate

In 1- 10 years same entry- recognizing the rebate loss over 10 years of the period

Profit and Loss account Dr. 0.25 (millions) ------

To Provision for Rebate on sales ac ------ 0.25(millions)  

Only in 10th year

In case of payment of rebate to the customer

Provision for Rebate on sales ac ------ 2.5(millions)

To Cash account 2.5(millions) ------

Question 4.

Provision for Rebate on sales ac Dr. ------ XXXX

To Retained earnings XXXX ------

(If not rebate is not claimed will be transferred to retained earnings)