Question

Q6. In July of 2016, Zeon, LLC entered into an agreement with Marz, Inc. to:

 make Marz its exclusive Power Tool supplier for Zeon and its member stores for four years;

 "aggressively and regularly" advertise and promote Marz's products;

 dedicate on average at least 12 lineal feet of shelf space to Marz products in its member stores; and

 purchase $25 million in Power Tools during the term of the agreement

Given Zeon’s volume purchase commitment, Marz agreed to pay Zeon $2 million as an "unearned advance allowance." Marz paid this to Zeon by check, and agreed to pay Zeon another $200,000 on the first, second, and third anniversaries of the agreement, provided that Marz was satisfied with Zeon's warehouse distribution arrangement. The contract refers to the total $2.6 million in payments as the "Zeon Allowance" and contains the following clause: Upon termination of this Agreement, Zeon will reimburse Marz on a pro-rated basis for any portion of the Zeon Allowance advanced to Zeon but not earned due to the failure by Zeon to purchase at least $25 million in Power Tools. During Zeon 2016 tax year, Marz paid the first $200,000 to Zeon. Zeon, LLC could not resell enough Power Tools to meet the minimum volume the contract called for, so it terminated the arrangement in October of 2017. Zeon’s termination letter acknowledged its obligation to pay back a pro-rated portion of the Zeon Allowance, and it repaid $1,461,857 to Marz in December. Zeon accounted for the up front cash as a liability at the time it received the cash. As Zeon purchased the goods for which it had the volume obligations, it subtracted pro rata portions of the advance cash discounts from what it paid. This had the effect of reducing the cost of goods sold (and increasing the taxable profits from sales) by the amount of the cash advances attributable to the goods sold.

Discuss Zeon’s inventory accounting practice.

Answer 1

Answer

A	Accounting entries on receipt of 'Zeon Allowanve'
	Particulars	Debit ($)	Credit ($)
	Bank A/c Dr	2,200,000
	Accounts Payable A/c		2,200,000
	(Being liability created on receipt of allowance)
B	Calculation of inventory purchased from Marz, Inc
	Total period from date of agreement to termination is July 2016 to October 2017
	Total agreed purchases during the period $ 25,000,000
	Zeon is eligible for annual allowance agreed amounting to $ 200,000
	Total amount received from Marz, Inc is $ 2,200,000
	Total amount retained by Zeon as allowance for products sold (i.e. 2,200,000-1,461,857) $ 738,143
	Total zeon allowance repaid on termination of agreement $ 1.461, 857
	Zeon purchases can be arrived by doing the below calculation
	=Total agreed purchases*(Allowance retained/Total allowance received)
	=25,000,000*(738,143/2,200,000)
	Zeon purchase price is = $ 8,387,989
C	Accounting entries on purchase of inventory
	Inventory receipt:
	Particulars	Debit ($)	Credit ($)
	Inventory A/c	8,387,989
	Accounts Payable A/c		8,387,989
	(Being inventory purchased)
	Adjustment of Zeon allowance (Assuming 100% goods sold)
	Particulars	Debit ($)	Credit ($)
	Accounts Payable A/c	738,143
	Inventory A/c		738,143
	(Being liability created on receipt of allowance is reversed on purchase of inventory)
	Sale of merchandise (Assuming 100% sold)
	Particulars	Debit ($)	Credit ($)
	Cost of goods sold A/c	7,649,846
	Inventory A/c		7,649,846
	(Being cost accounted on sale of inventory)
D	Discussion of Zeons inventory accounting practice
	1. As per US GAAP and any other standards for that matter, inventory shall be accounted at its cost price including other costs incurred to bring it to place of business.
	2. The accounting rule is applicable irrespective of the purchase obligation. Whether it is volume based obligation or not is not relevant.
	3. The present practice of Zeon has impact on cost of goods sold and sales margin.
	4. Cost of goods sold has been decreased by $ 738,143 and consequently sales margin increased by that amount.
	5. It is extended by vendors as part of their marketing scheme.
	6. Ideally, this zeon allowance shall be accounted as other income in books.