Question

Enchanted Brides Ltd. sells complete bridal ensembles. The most expensive part of the ensemble is the wedding gown. Recognizing that some of its customers may not have enough immediate funds to purchase one of its gowns, the store provides a layaway plan. The customer selects a gown and the store agrees to hold the gown until it is paid for. The store sets up a monthy payment schedule for the customer, extending the payment time over six months to a year. The store charges an additional $35 layaway application fee and $100 in possible default charges. If all payments are made on schedule, the default charge reduces the final payment. If the customer defaults, the $100 is not refunded.

Question: Using the revenue recognition criteria, explain how the store should account for the monthly payments from the customer. Should the $35 storage fee be treated as revenue? Why or why not? Shoud the $100 default charge be treated as revenue? Why or why not? When should the store recognize the original cost of the wedding gown?

Answer 1

Revenue is the gross inflow of cash, receivables or other considerations from the above activities. In case of sale of goods and services revenue is measured by the amount of charges made to customers or clients for goods sold or services rendered. In case of use of the resources of the business by others, revenue is measured by the charges and rewards arising from the use of such resources by others. Any amount collected on behalf of third parties is not recognised as revenue. In case of sale of goods, normally revenue is recognised when the significant risk and reward of ownership of the goods are transferred to the buyer. If the seller retains, significant risk of ownership, the transaction should not be recognised as sale. Where only a non-significant risk of ownership is retained by the seller for ensuring payment of price due, the transaction is treated as sale and the value of the transaction is recognised as revenue.

Here only a non-significant risk of ownership is retained by the seller for ensuring payment of price due, therefore the total price f the good is recognised as revenue at the time of sale. Then the monthly payment is to be written off from accounts receivable as and when it is received.

Storage fee is to be treated as revenue because it is non-refundable. So once it is earned, it becomes a revenue.

Default charges is not a revenue because it is refundable in case of all the monthly payments are made on time. It is an amount for the compensation of bad debt. Its realisation is uncertain.

Here only a non-significant risk of ownership is retained by the seller for ensuring payment of price due, therefore the original cost of the gown is recognised as revenue at the time of sale.