The issue is that SAC has elaborated a marketing initiative in which a free for-life gym membership will be given to the selected client from a random draw if this does more push ups than Harry. Unknown effect of the next year's future competition and awarded prize ($50 x 12 months = $600 a year) in the financial statements and whether or not it should be recorded at the year end Dec 31, 2019 financial statements. Do the free membership challenge meet the definition of a liability, if so, should it be recognized?

Implication

Is there a liability that should be recorded or not? What will be the implication in the financial statements and debt to equity ratio if the free membership challenge meets the criteria of a liability.

Analysis

• ASPE does not have specific measurement standards for non-financial liabilities

• It is an offer to customers with evidence of having use a particular service after its purchase

• It is a marketing initiative to increase sales

• Total obligations at period end are recognized as a liability, estimated cost is expensed in the current period

• The matching principle will be violated without properly accounting for the free membership earned by the customer if this wins the challenge (when the event occurs)

• Recording a liability can affect the D/E ratio for the Dec 31, 2019 year end

As per ASPE a liability is an obligation that arises from past transactions or events, which may result in a transfer of assets or provision of services.

Liabilities have three essential characteristics:

1.They embody a duty or responsibility to others: Yes, Harry has automatically entered clients into the draw every time they enter the gym with the purpose of earning a future life-free membership

2.The entity has little or no discretion to avoid the duty: Yes, Harry is sure about the draw, this will occur on Feb 5 of the following fiscal year, being the competition on the 25th of that month. The award of the life-time membership has a likelihood of not occurring if Harry wins the competition.

3.The transaction or event that obliges the entity has already occurred: No, the draw and competition has not taken place, this event hasn't occurred in the past.

Alternative(s)

1. Record a liability (e.g. membership pass) when the event occurs (Harry awards the membership), based on the matching purpose principle. The possibility for a customer to win the competition after the draw is very unlikely considering Harry's physique.

2. Record liability and match expense to the current period since there is a possibility of Harry having to provide the life-time free membership. Moreover, Harry has the event organized and pleaded that the winner of the competition will be awarded the promised price.

Recommendation

Alternative 1 - There is no need to record a liability at the moment since there is a possibility that the transaction does not occur in the coming year, also there is no record of it occurring previously. In order for the free-lifetime membership to be awarded, the person needs to compete against Harry. Harry's physique is a significant advantage against the person he is competing with which provides a lot of uncertainty whether or not someone will be able to get awarded the price.

In case that the customer does win and receives the prize of $600 a year (12 months x $50), the price can be expensed the following way per year for the free membership.

Feb 25, 2020

Account	Dr	Cr
Accounts receivable	600
Membership Pass		600

Answer rating: 100% (QA)

A liability under ASPE Accounting Standards for Private Enterprises appears to exist in this case du... View the full answer