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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...
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…
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