Question

Supply Club, Inc., sells a variety of paper products, office supplies, and other products used by businesses and individual consumers. During July 2021 it started a loyalty program through which qualifying customers can accumulate points and redeem those points for discounts on future purchases. Redemption of a loyalty point reduces the price of one dollar of future purchases by 20% (equal to 20 cents). Customers do not earn additional loyalty points for purchases on which loyalty points are redeemed. Based on past experience, Supply Club estimates a 60% probability that any point issued will be redeemed for the discount. During July 2021, the company records $135,000 of revenue and awards 125,000 loyalty points. The aggregate stand-alone selling price of the purchased products is $135,000. Eighty percent of sales were cash sales, and the remainder were credit sales.

 

Required:
1. Prepare Supply Club’s journal entry to record July sales.
2. During August, customers redeem loyalty points on $60,000 of merchandise. Seventy-five percent of those sales were for cash, and the remainder were credit sales. Prepare Supply Club’s journal entry to record those sales.

 

Answer 1

Requirement 1

The delivery of Supply Club’s normal products is one performance obligation. The promise to redeem loyalty points for discounts on purchases represents a material right to customers that they would not receive had they not bought Supply Club’s products, so that the discount provided upon redemption of loyalty points represents a second performance obligation. The loyalty program provides customers with a discount option on future purchases. Thatoption is capable of being distinct because it could be sold or provided separately, and it is separately identifiable, as it is not highly interrelated with the other performance obligation of delivering products under normal sales agreements (the customer can redeem loyalty points for future purchases). Therefore, the promise to redeem loyalty points qualifies as a performance obligation.

 

Because there are two performance obligations associated with a single transaction price ($135,000), the transaction price must be allocated between the two performance obligations on the basis of stand-alone prices.

 

Supply Club’s estimated stand-alone selling price of the loyalty points is:

 

Value of the loyalty points:

     125,000 points × $0.20 discount per point =       $ 25,000

Estimated redemption                                                       × 60%

Stand-alone selling price of loyalty points:                $ 15,000

Stand-alone selling price of purchased products:     135,000

Total of stand-alone prices                                          $150,000

 

Supply Clubmust identify each performance obligation’s share of the sum of the stand-alone selling prices of all deliverables:

Supply Clubthen allocates the total selling price based on stand-alone selling prices, as follows:

 

The journal entry to record July sales would be:

                          

Cash ($135,000 × 80%)	108,000
Accounts receivable ($135,000 × 20%)	27,000
Sales revenue		121,500
Deferred revenue–loyalty points		13,500

Requirement 2

Cash ($60,000 × 75% × 80%)*	36,000
Accounts receivable ($60,000 × 25% × 80%)*	12,000
Deferred revenue–loyalty points**	10,800
Sales revenue (to balance)		58,800

*Sales are discounted by 20% when points are redeemed, so only 80% of each dollar sold is received. 75% of sales are for cash, and 25% are on credit. 

**Supply Club expected that 60% of the 125,000 awarded points would eventually be redeemed. 60% × 125,000 = 75,000. Therefore, the 60,000 August redemptions constitute 60,000 ÷ 75,000 = 80% of total redemptions expected. Because Supply Club assigned $13,500 of deferred revenue to the July loyalty points, Supply Club should recognize revenue of $13,500 × 80% = $10,800. 

 

When deferred revenue associated with the loyalty points was first recognized, a total of$13,500 was assigned to the points, given an expectation that 75,000 points would be redeemed. Therefore, each redeemed point results in recognition of $13,500/75,000 or $0.18/point.

 

When 60,000 points are redeemed, they reduce the cash collected (now or in the future) by20%. Thus, total cash collected will be $60,000 x 80% = $48,000. 75%, or $36,000, iscollected immediately, and another $12,000 is collected when the receivable is collected.Thus, total revenue recognized upon sale is $36,000 (associated with cash sales) + $12,000(associated with A/R) + $10,800 (deferred revenue associated with loyalty pointredemption), totaling $58,800.

When 60,000 points are redeemed, they reduce the cash collected (now or in the future) by20%.