Reference no: EM132657669

INTRODUCTION

• ABC Warehouse operates a chain of 35 discount retail appliance and electronics stores in Michigan, Ohio, and Indiana. The firm is privately held and began operations with a single Michigan location in 1964. ABC's operations are similar to national retailer BestBuy, but on a smaller scale.

• ABC offered a special promotion to its customers, promising a 50 percent cash rebate ten years after the date of purchase. The case asks you to consider the economics and judgment made by management in deciding to offer this promotion. You are then asked to decide how ABC should account for sales revenue and the promised rebates under this promotion. The case requires you to consider the role of estimation in accounting and financial reporting, including appropriate consideration of the potential contingent liability.

THE ABC WAREHOUSE REBATE OFFER

ABC Warehouse advertised the following special offer to customers:

A 50 percent cash rebate on your purchases in ten years.

The offer was subject to several conditions:

• This offer applies to all purchases.
• The application form and a copy of the store receipt must be mailed within 21 days of purchase. Upon receipt, ABC would issue a rebate certificate.
• The rebate certificate must be available ten years from today and must be submitted within 90 days of the ten-year maturity date.
• Customers must survive; rebates are not transferable.
• Customers cannot misplace any of the documents.

Customers are protected even if ABC goes out of business or is sold. ABC will purchase insurance to guarantee payment of the rebates in the (unlikely) event they go bankrupt. Assuming all of the conditions were met, ABC would send a 50 percent cash rebate after ten years.

The offer received attention in the local and regional business press. The offer appeared unique in the U.S., but the reporter noted that such promotions had been successfully employed in the past in both Canada and Europe.

The offer was made near the end of ABC's fiscal year (Year 0). Assume that the promotion ran for two weeks and generated sales of $5 million. For simplicity, you may assume that all sales were cash sales. You may also assume the ABC's gross margin is 20 percent of sales.

Problem 1: What amounts will appear in ABC's Balance Sheet and Income Statement with respect to this problem (year 0 only). Provide the account name(s) and the amounts. Show supporting calculations for any amounts not given in the problem. One sheet of paper limit. (fyi, this is a true story; for my accountants, this happened pre-SOX).