Certain membership organizations (ORGs) provide their members with discounts or cash refunds when they use registered credit cards at specific hotels, restaurants, or other business establishments (BEs). The BE is listed in the ORG’s directory, and the members use their registered credit card when patronizing the BE. Most participating BEs are restaurants that usually do not know whether patrons are members of an ORG using a registered card that provides a discount.
ORGs make their money primarily through advancing cash to the BEs that is repaid when ORG members use their registered credit card at the BE. The BE submits the credit card receipt, but the credit card company pays the ORG.
Example
An ORG advances a BE $50,000 and lists the BE in its directory. An ORG member eats at the BE, a restaurant, spending $100 for the meal using a credit card registered with the ORG (for simplicity, the total amount paid for the meal includes tax and tip). The BE deposits the credit card slip in the normal course of business. The credit card company pays the total $100 charge to the ORG, which reduces the loan to the BE by $50 and increases the ORG’s revenues by $50, leaving a $49,950 balance due to the ORG from the BE.
Contract Terms
Under most of these contracts, the amount advanced by the ORG can be repaid only through ORG members’ use of their registered credit cards at the BE or through some breach of the agreement by the BE. A breach might be the BE’s going out of business or no longer accepting credit cards. When a breach occurs, the ORG would be an unsecured creditor.
The Accounting Treatment
The question for accountants is, how are these transactions recognized by the BE?
The initial transaction is straightforward: The BE recognizes a $50,000 increase of cash and the creation of a $50,000 liability to the ORG. Because the BE does not know whether a patron is paying with a credit card registered with the ORG, it recognizes the sale at the gross amount of $100 and increases its cash account for the same amount. However, when the BE receives the advice of the debited charge slip, the accounting treatment begins to diverge. The BE would debit its liability to the ORG for $50, credit its cash account for $100, and have an additional $50 in debits to find. The divergence in practice occurs in the treatment of that unleashed $50.
Current Alternative Treatments
Some BEs believe that the $50 charge is a promotion expense because they entered into the agreement in order to attract new customers by being listed in the ORG directory. Under this theory, they set up the initial transaction recognizing a liability of $100,000 and prepaid advertising of $50,000 along with the $50,000 cash receipt.
Others charge advertising expenses for the full $50,000 immediately because they believe that the accounting treatment should follow practice for other-than-direct response advertising, which is to expense it immediately. However, if the program is truncated due to a subsequent business agreement or breach, the actual liability would be limited to the original $50,000 and this approach would unfairly inflate liability and expense.
Still others argue that the repeated inclusion in directory updates until the debt is repaid makes this arrangement a form of direct response advertising. In these cases, the offset to the $100 credit to cash would be a debit to the liability of the ORG account. However, in a direct-response advertising scenario, a subsequent adjustment relieving the prepaid account and charging expense would occur. For financial reporting purposes, the remaining balance in the prepaid account would be offset against the remaining liability to properly reflect the balance due at the balance sheet date.
Still other BEs view this advance as a loan without a stated interest rate or due date. The accounting under this assumption would be for the BE to recognize $50 in interest expense at the receipt of the debit advance. Although the CPAs of many BEs favor this approach, BE management feels this treatment unjustly inflates their financing costs. Because these arrangements are usually made for amounts expected to self-liquidate within a year, the accounting treatment would result in an interest rate exceeding 50 percent. BE management argues that they never intended to borrow money at such an inflated rate of interest. Accordingly, some of these BEs allocate a portion of the charge to advertising and promotion expenses and the remainder to interest expenses.
A third approach, favored by the author, admittedly does not have wide support in practice. Under this approach, the advance would be accounted for as prepaid revenue, and sales would be debited for the $50 as soon as the BE receives notification that it has provided services for a party whose usage of the BE has been prepaid.
Under this approach, the relationship between ORG and BE is equivalent to arranging for a company to provide meals for certain guests at no cost to them and at a discounted rate; the prepayment is the company’s incentive. In the author’s opinion, this treatment reflects the substance of the transaction. However, BE management generally opposes this approach because it reduces net sales and can have a severe adverse impact on gross profit.
Until the standard setters resolve this question, the choice of accounting method for the transaction will remain at the client’s discretion.
Edited by Robert H. Colson, CPA
Editor’s Note: This column is devoted to accounting and auditing issues
that arise in the normal course of CPA practice. Some articles cover events
and transactions for which there may be alternatives in current practice.
Others highlight problems that CPAs have encountered in implementing accounting
or auditing standards. Most of the situations presented in this column
come from participation in meetings of technical committees of the New
York State Society of CPAs.
Barry Wexler of Marks Paneth & Shron took the lead in preparing
the column’s first installment. Wexler’s article summarizes the major
points of a technical practice session discussion during the November
meeting of the Auditing Standards and Procedures Committee.
