Increasing the Customer Base of the Runway Discount - Essay Example

? for Admin] The format and number of references of the report is as per the requirements given in the document ‘caserequirements.pdf’ Facts of the Case Study The Runway Discount is a private firm sale of high-end fashion items. The company wants to increase their online as well as the customer base. In this regard, the company started ‘Refer a Friend’ program in which the existing customer would get an amount of twenty five dollars ($ 25) if the existing customer would refer a new customer to purchase items from the website of the Runway Discount Company. The twenty five dollar ($ 25) would be transferred to the existing customer account if and only if the referred new customer purchase item from the company’s website. Moreover, after transferring of twenty five dollars ($ 25) to the account of the existing customer, the money can only be utilized by the customer on the purchasing of new items from the company’s website. The case study pertains to referral credit, in this regard; the document presents a thorough discussion on the said topic. It is pertinent to state that the referral credit should be recorded in the income statement as a marketing expense and this money is spent in an effort to bring in more clients for the company. The company is spending additional money to attain more customers and is expanding its scope. As a marketing strategy, the company is using its existing customer base to bring in more customers by offering them incentives on referring the site to other people. In the long run this additional money spent in the form of referral credits will be beneficial for the company as it will result in an increase in the sales and revenues. It cannot be recorded as a reduction in revenues as this will not provide a clear picture and future increase in customers and revenues cannot be attributed to this money spent. On the other hand, if twenty five dollars ($ 25) referral credit inducement offered to the Runway Discount Company’s customers, the offer can bring in more new customers for the company. And the new customers would be the vital reason for increasing sales, after the sales increment, the increase should explain if twenty five dollars ($ 25) amount is recorded as a marketing expense. Thus, it is suggested that in order to provide a more accurate depiction to the investors, it is advisable to record referral credit as a marketing expense (Gregory, 2011). When would Runway record the $ 25 Referral Credit? It is relevant to know that the Runway Company would record twenty five dollars ($ 25) referral credit in its books at the time when the new customer referred by an old or existing customer, makes a purchase from Runway Company’s website. When the new customer makes a purchase, the Runway Company is bound to give twenty five dollars ($ 25) referral credit to its customer. In other words twenty five dollars ($ 25) become a liability of the company. However, if an existing customer refers the portal to a third person, not familiar to the website but the person after surfing the site does not make a purchase; the Runway Company will not record any referral credit in its books. When the new customer makes a purchase, twenty five dollars ($ 25) will be recorded as a referral fee in the records of the Runway Company. Thus, the referral credit will be recorded in the financial statements of the Runway Company only if the new customer makes a purchase. Against this referral fee account, another account by the name of referral fee payable will be created. In this way, the company would be bound to pay the referral credit to the existing customer referred new customer, as well as the same amount would be shown as expenditure or marketing campaign expense in the records of the company. $ 25 Referral Credit earned by the Existing Customer: When the new customer makes a purchase, the existing customer will earn twenty five dollars ($ 25) referral credit. This twenty five dollar ($ 25) referral credit will be recorded as a referral fee in the books of Runway Company. The referral fee will be debited against which the credit entry will be recorded as a referral fee payable. For simplicity let’s assume that the new customer makes a purchase worth $100. This transaction will be recorded as follows (McCarrol and Khatri, 2012): Debit Credit Cash $ 100 Inventory $ 100 Referral fee $ 25 Referral fee payable $ 25 $ 25 Referral Credit redeemed against a $ 100 purchase: The twenty five dollar ($ 25) referral Credit can be redeemed or utilized by the old customer whenever he or she makes a purchase. If the old or existing customer makes a purchase of hundred dollars ($ 100) and wants to redeem twenty five dollars ($ 25) referral credit earned, he or she will have to pay seventy five dollars ($ 75) instead of hundred dollars ($ 100). If the customer has redeemed the referral credit, the referral fee payable will be reduced by twenty five dollars ($ 25) and will be debited in the accounts of the Runway Company. Debit Credit Cash $ 75 Inventory $ 100 Referral fee payable $ 25 Financial Statements The three (3) basic balance sheet segments are assets, liabilities and owners’ equity (Accounting-Simplified, 2013). The basic balance sheets give investors a picture as to what the company possesses (known as Assets) and owes (known as Liabilities), as well as the amount invested by the owners (known as Shareholders). The balance sheet depicts the financial position of a company on a particular day. Since twenty five dollars ($ 25) become a liability of the company when the new customer makes a purchase, the balance sheet of the Runway Company for the day will depict the twenty five dollar ($ 25) referral credit earned by the existing customer for introducing the new customer makes a purchase. The income statement provides the depiction of the financial performance of the company by giving a summary of how the business generates its revenues and expenses through both operating and non-operating activities. The income statement or the profit and loss statements are created for a specific accounting period which may be a month, a quarter or a year. As a referral credit is recorded as an expense in the income statement, it will affect the overall profits of the Runway Company. The referral credit earned by all the customers during the entire accounting period is recorded as a referral expense in the income statement. Runway is planning to adopt IFRSs in the near future. What is the relevant accounting guidance they would follow under IFRSs? The International Financial Reporting Standards (IFRSs) are developed to coordinate and communicate the financial statements of the businesses so that the company’s accounts can be comprehended and comparable across the World. If the Runway Company adopts IFRS system, the accounting guidelines in accordance with which referral credit will be recorded in the financial statements of the Runway Company is IFRIC-13 customer loyalty program (IFRS, n.d). This principal states that “IFRIC 13 addresses accounting by entities that grant loyalty award credits (such as 'points' or travel miles) to customers who buy other goods or services. Specifically, it explains how such entities should account for their obligations to provide free or discounted goods or services ('awards') to customers who redeem award credits.” (IASplus, n.d) If the above mentioned principal applied to our case it becomes clear that in accordance with IFRSs if an old or existing customer of the Runway Company refers a new customer to the website then when the new customer makes a purchase Runway is bound to grant its old customers referral credit which can be redeemed on the discretion of the old customer. When the customer uses a referral credit he or she will be able to buy goods or services on discounted prices. Effect of IFRIC 13 IFRIC 13 implies that the Runway Company should allocate some revenue to referral credits provided to old customers when a customer referred makes a purchase, as by referring other customers to the portal they are implicitly paying for the credits they receive. IFRIC 13 requires the Runway Company to assess the value of the credits to the customer and defer this amount as a liability (referral expense payable) until the credit is redeemed by the existing customers. When the credit is redeemed it can be recorded as a referral expense in the income statement. Use of IFRIC 13 will standardize practices with Runway and ensure that the organization always measures obligations for customer referral credit in the same way as they measure other obligations to customers References IFRS. (n.d). IFRIC Customer Loyalty Programmes. Retrieved from: http://www.ifrs.org/Current-Projects/IFRIC-Projects/IFRIC-13-Customer-Loyalty-Programmes/Pages/IFRIC-13-Customer-Loyalty-Programmes.aspx Gregory, A. (2011). Using a Client Referral Program to Grow Your Business. Retrieved from: http://www.sitepoint.com/using-a-client-referral-program-to-grow-your-business/ IASplus, (n.d). IFRIC Customer Loyalty Programmes. Retrieved from: http://www.iasplus.com/en/standards/ifric/ifric13 Accounting-Simplified. (2013). Types of Financial Statements. Retrieved from: http://accounting-simplified.com/financial/statements/types.html McCarrol, J. and Khatri, G. R. (2012). Fair Value Measurement Under IFRS 13. Retrieved from: http://www.deloitte.com/assets/Dcom-Ireland/Local%20Assets/Documents/Public%20relations/JohnMcCarroll_GoindRamKhatri.pdf Read More