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How should the $25 Referral Credit be recorded in Runway's income statement?

In accordance to ASC 605-50-45 Revenue Recognition, a cash consideration handed to a consumer by a vendor or retailer is deemed a decrease in the selling prices of the products or services retailed. This would imply that these cash considerations would be deemed as an expense and a decline in the revenue to be generated by the vendor. Nonetheless, the cash consideration can be deemed as an expense if it solely meets two requirements. First, the cash consideration has to give rise to an identifiable benefit that is separable from the purchase of the recipient, in the sense that the vendor could have achieved the benefit through a third party, and not the purchaser. Secondly, the value that is provided has to be reasonably approximated by the vendor (IAS Plus, 2016).

In this case, Runway does meet these two particular requirements because the $25 credit surpasses the estimated fair value of the benefit received. In addition, Runway receives an identifiable benefit in interchange for the $25 consideration. Bearing this in mind, Runway should record the $25 referral credit as a marketing expense or revenue reduction in the income statement of the company (IAS Plus, 2016).

When would Runway record the $25 Referral Credit?

In accordance to FASB Codification 605-50 Customer Payments and Incentives,

i. if the consideration is in the form of goods, services, or cash offered willingly by a vendor and without any charge to consumers

ii. can be used or comes to be exercisable by a consumer in a single exchange transaction,

then a vendor shall recognize the cost of the sales incentive:

1. At the time a prevailing customer obtains the $25 referral credit

2. At the time when the prevailing consumer actually makes use of the $25 referral credit to purchase a good or merchandise (Epstein et al., 2009).

The $25 referral credit is acknowledged as an expense by Runway when the new consumer makes his or her first purchase and this would obligate the crediting of the referring consumer (Flood, 2015).

What are the journal entries Runway would record when the $25 Referral Credit is earned by the Existing Customer?

When the existing customer earns the $25 referral credit, then the entries recorded by Runway would include debiting the sales revenue account by $25 dollar and crediting the liability account by the same amount of $25.

Dr: Sales Revenue $25

Cr: Liability Account $25

What are the journal entries Runway would record when the $25 Referral Credit is redeemed against a $100 purchase made by the Existing Customer?

When the $25 referral credit is redeemed against a purchase of $100 made by the existing customer, then the entries that would be recorded by Runway would include the following:

Dr: Accounts Receivable $75

Dr: Cost of Goods Sold $100

Cr: Sales $75

Cr: Liability of referral credits $25

Cr: Inventory $75

These entries outline the amount of money that the company will be generating from the sale, the cost of the good, the amount of the product that was in fact sold, the new liability that is being paid for by the company through the $25 credit and the decrease in inventory. It is imperative to note that devoid of the transaction by the new consumer, there would be no redeeming of the referral credit. This implies that the second journal entry would be different.

Runway is planning to adopt IFRSs in the near future. What is the relevant accounting guidance it would follow under IFRSs?

Taking into account that Runway is planning to adopt International Financial Reporting Standards in the near future, the relevant accounting guidance it should follow is International Accounting Standard 18 (IAS 18). In accordance to IAS 18, revenue is measured at the fair value of the consideration received or receivable taking into consideration the amount of any discounts in trade that are permitted by the entity (IFRS, 2012). IFRS 15 Revenue from Contracts with Customers will be effective on or after 1 January 2018. In accordance to IFRS 15, Runway would report the discount handed to the consumer as a loss in revenue, unless the business is able to specifically ascertain the goods or services transferred. Also, any revenue received from a transaction of this kind ought to be recorded at the fair value of the cash consideration after deducting any discounts that are applicable to the accounting transaction. This is centered on the fact that according to IFRS 15, a good or service that is promised to consumer is deemed to be distinct if it satisfies two requirements. First, the consumer is able to benefit from the good or service on either its own or together with other resources that are freely accessible to the consumer. Secondly, the company's promise to make a transfer of the good or service to the consumer is distinctly recognizable from other promises of the contract (IAS Plus, 2016).

Conclusion

Runway Discount issues a $25 credit for every referral made. In accordance to the Generally Accepted Accounting Principles (GAAP), this accounting transaction may be recorded as a marketing expense. On the other hand, in accordance to IFRS, then this accounting standard may be recorded as a loss in revenue. The FASB presently recognizes revenue on a principle-based approach.

References

Epstein, B. J., Nach, R., & Bragg, S. M. (2009). Wiley GAAP 2010: interpretation and application of generally accepted accounting principles. Hoboken: John Wiley & Sons.

Flood, J. M. (2015). ASC 505 Equity. Wiley Gaap 2015: Interpretation and Application of Generally Accepted Accounting Principles 2015, 555-585.

IAS Plus. (2016). IFRS 15 -- Revenue from Contracts with Customers. Retrieved from: https://www.iasplus.com/en/standards/ifrs/ifrs15

IAS Plus. (2016). Revenue Recognition. Retrieved from: https://www.iasplus.com/en-us/standards/fasb/revenue/asc605

IFRS. (2012). IAS 18 Revenue. Technical Summary.