Deloitte Trueblood Cases Intro Case ReferaFriend Program 2012

Deloitte Trueblood Cases – Intro Case Refer-a-Friend Program (2012) 1

Background $25 credit Existing Customer New Customer 2

Background • The $25 Referral Credit represents the fair value of the cost Runway would pay to acquire a new customer from an unrelated third party or marketing firm who is not a purchaser of its products. 3

Case Specific Questions • How should Runway account for the $25 credit in its Income Statement? • When would Runway record the $25 Referral Credit? • What are entries when $25 Referral Credit is earned by Existing Customer? • What are entries when $25 Referral Credit is redeemed against a $100 purchase from Existing Customer? 4

General Questions • What are the facts? • What are the incentives for this transaction? • How would the investor best be served by this information? • What do you think the accounting should be? • How do conservatism and the conceptual framework affect your thinking? 5

Alternative A When new customer purchases: Dr. Marketing expense $25 Cr. Referral credit liability $25 When existing customer redeems: Dr. Cash Dr. Referral credit liability Cr. Revenue $75 $25 $100 6

Alternative B When new customer purchases: Dr. Cust. Incentive (contra-rev. )$25 Cr. Referral credit liability $25 When existing customer redeems: Dr. Cash Dr. Referral credit liability Cr. Revenue $75 $25 $100 7

Question • Does Runway have a liability to the existing customer at the moment the new customer makes her first purchase from Runway? 8

Alternative C When new customer purchases: (Nothing) When existing customer redeems: Dr. Cash Dr. Marketing Expense Cr. Revenue $75 $25 $100 9

Alternative D When new customer purchases: (Nothing) When existing customer redeems: Dr. Cash $75 Dr. Cust. incentive (contra-rev. )$25 Cr. Revenue $100 10

Question • Which alternative is the strongest? A. Treat credit as a marketing expense at the time of the new customer purchase B. Treat credit as a reduction in revenue at the time of the new customer purchase C. Recognize marketing expense only when existing customer makes a purchase D. Recognize as a reduction in revenue only when existing customer makes a purchase 11

Additional General Questions • What does codification/IFRS say? • Do you agree with what it says? • Any SEC guidance on this? 12

Codification ASC 605 -50 -45 -2 Cash consideration or sales incentives given to a customer are presumed to be a reduction in selling price unless the following criteria are both met: 1. Vendor receives an identifiable benefit in exchange for the consideration given to the customer 2. Vendor can reasonably estimate the fair value of the benefit 13

Codification ASC 605 -50 -25 -3 If it is a reduction of revenue, the amount should be recorded and recognized “at the later of the following: a) The date at which the related revenue is recognized by the vendor; b) The date at which the sales incentive is offered” 14

Question • Which alternative is the strongest now? A. Treat credit as a marketing expense at the time of the new customer purchase B. Treat credit as a reduction in revenue at the time of the new customer purchase C. Recognize marketing expense only when existing customer makes a purchase D. Recognize as a reduction in revenue only when existing customer makes a purchase 15

Additional General Questions • What do other firms do or say about this transaction? Divergence of opinions? • Any other situations analogous to this in practice? 16

“We record these promotions as a reduction in revenue when earned by the customer. ” 17

The advertisements are sufficiently separable from the retail customer’s purchase of our products as we could purchase similar advertising from a party other than the retail customer. Nike November 2011 correspondence letter with SEC 18

“We pay commissions to participants in our Associates program when their customer referrals result in product sales and classify such costs as ‘Marketing’ on our consolidated statement of operations. ” -Amazon 10 -K (2011) 19

Question • Which alternative is the strongest now? A. Treat credit as a marketing expense at the time of the new customer purchase B. Treat credit as a reduction in revenue at the time of the new customer purchase C. Recognize marketing expense only when existing customer makes a purchase D. Recognize as a reduction in revenue only when existing customer makes a purchase 20

The solution is just the starting point! Learn judgment, not rules! 21

Common Questions • What are the facts? • What are the incentives for this transaction? • How would the investor best be served by this information? • What do you think the accounting should be? • How do conservatism and the conceptual framework affect your thinking? 22

Common Questions • What does codification/IFRS say? • Do you agree with what it says? • What do other firms do or say about this transaction? Divergence of opinions? • Any SEC guidance on this? • Any other situations analogous to this in practice? 23

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