Revenue Recognition Case Your client, Stitch Fix Inc. (www.stitchfix.com), sells

Question

Revenue Recognition Case

Your client, Stitch Fix Inc. (www.stitchfix.com), sells clothing and personal accessories hand selected by a personal stylist, delivered to clients’ doors. In an effort to increase its sales and customer base, Stitch Fix implemented a customer referral marketing campaign whereby existing customers can refer friends to Stitch Fix and receive a $25 credit towards the purchase of future merchandise. The terms of the program are as follows:

Stitch Fix offers existing customers a $25 credit if the existing customer refers a friend to Stitch Fix’s website and the new customer purchases merchandise from Stitch Fix.

After a purchase is made by the new customer, the existing customer receives a $25 credit to be applied to a future purchase from Stitch Fix.

The $25 referral credit represents the fair value of the cost Stitch Fix would pay to acquire a new customer from an unrelated third party or marketing firm who is not a purchaser of its products. The program is open to all of Stitch Fix’s customers.

Required: Stitch Fix has contacted you for advice about the accounting for this new referral program under GAAP rules. Write a memo to Stitch Fix Co. answering the following questions:

How should the $25 referral credit be recorded in Stitch Fix’s Income Statement – as a reduction of revenue or as a marketing expense?

When would Stitch Fix record the $25 credit? What are the entries Stitch Fix would record when the $25 referral credit is earned by the existing customer? What are the entries Stitch Fix would record when the $25 credit is redeemed against a $100 purchase made by the existing customer?

Stitch Fix is planning to adopt IFRS in the near future. What is the relevant accounting guidance they would follow under IFRS and what are the similarities/differences from GAAP?

Stitch Fix is has heard about and is concerned about the upcoming implementation of the new revenue standard, and is hopeful implementation will continue to be delayed. Provide Stitch Fix with a summary of the major changes to the revenue standard and when Stitch Fix should plan to implement the new standard.

Using the database Orbis (available through the library website), what is: a) the number of current shareholders, b) the 2015 number of employees, c) the name of the CEO, and d) the estimated revenue for 2015 for Stitch Fix? Note that this is not part of the memo, but please go ahead and include it within the same document – just put it at the end as a separate section.

Explanation / Answer

Memorandum To: xxxxxxxx

Date: xxxxxx

From: xxxxxx

Re: Accounting Guidance for Refer-a-Friend Program in Stitch Fix Discount

Facts

Stitch Fix Discount is a privately held online retailer which sells discounted high-end fashion. It has launched the “Refer-a-Friend Program” as a marketing campaign to increase sales. The Program involves incentivizing existing customers to refer their friends to Stitch Fix’s website. When an existing customer refers someone who makes a purchase on Stitch Fix’s website, the referring customer receives a $25 credit to be applied to a future purchase. The $25 referral credit represents fair value which is same as it would have paid to third party or marketing firm for acquiring new customers.

Issues

The following accounting issues have been identified for the company:

1. How the $25 referral credit should be recorded in Stitch Fix’s income statement as a reduction of revenue or as a marketing expense.

2. When the $25 referral credit should be recorded as a liability, the entries to be recorded when (a) $25 Referral Credit is earned by the Existing Customer and (b) $25 Referral Credit is redeemed against a $100 purchase made by the Existing Customer.

3. Accounting guidance for Stitch Fix to adopt IFRS.

Sol

The first accounting issue associated with Runway Discounts Refer-a-Friend program is identifying how the $25 referral credit should be recorded in Runways income statement. Is this consideration an adjustment of the selling prices of the vendor’s products or services, and therefore characterized as a reduction of revenue, or is it a cost incurred by the vendor for assets and services received from the customer and therefore characterized as a cost or expense? By implementing its Refer a Friend Program, Runway Discount is taking the proper steps to increase its customer base, and in turn, its sales, With the application of his program, however, there are some additional procedures that must be followed recording transactions involving the $25 referral credit. According to FASB codification 605-50-45-1 a vendor may give a customer a sales incentive or other consideration. An adjustment of the selling prices of the vendor’s products or services will therefore be characterized as a reduction of revenue when recognized in the vendor’s income statement.

The next significant accounting issue is regarding when Runway should record the $25 referral credit as a liability: FASB codification 605-50-25-3 states that for a sales incentive offered voluntarily by a vendor and without charge to customers that can be used by a customer as a result of the single exchange transactions, a vendor shall recognize the cost of the sales incentive at the later of the following: (a) at the time an existing customer receives the $25 referral credit, or (b) at the time the existing customer actually uses the $25 referral credit to make a purchase.

When the existing customer earns the $25 referral credit, Runway would have to record the following entries. Since the referral credit is reduction in revenues, Sales Revenue would be debited by $25, and there would be a credit entry of $25 to a liability account

When the $25 referral credit is redeemed against a $100 purchase made by the existing customer, the existing customer only pays $75 after the settlement of $25 referral credit. Thus the company only gets cash $75 for the sales of $100 merchandise and rest $25 is settled by the referral credit.

Regarding accounting guidance for Runway to adopt IFRS, since the company is a online retailer, it is a small enterprise and thus it is governed by International Financial Reporting Standard for Small and Medium-sized Entities (IFRS for SMEs, 2009). As per IFRS for SMEs section 35 “Transition to the IFRS for SMEs”, the following guidelines have been provided:

2.     The accounting policies that an entity uses in its opening statement of financial position under this IFRS may differ from those that it used for the same date using its previous financial reporting framework. The resulting adjustments arise from transactions, other events or conditions before the date of transition to this IFRS.

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