IFRS 15 (?) - cost of free gift

[sgaccountant]

Hi Guys,

I interviewed for a job and this technical question was asked of me:

You are a fruit seller. You sold an apple (purchased at $2) for $5. As part of sales campaign, you gave a bag (purchased at $6) free of charge with the purchase.
What would be your double entries?

This was my answer:

Debit cash $5
Credit sales revenue (apple) $2.27 [5/(5+6)*5]
Credit sales revenue (bag) $2.73 [6/(5+6)*5]

Debit COGS $8
Credit Inventory $8

The interviewer mentioned that it's weird that the COGS of $8 is higher than the sales revenue of $5 and hinted that the portion of expense that is greater than sales revenue should be allocated to another expense account. I tried referring to IFRS 15 and googling but I cannot find any guidance on such a scenario.

What should the double entries have been?

Thanks for your kind advice!

[Marek Muc]

I agree with you in this scenario! There's nothing in IFRS 15 that prohibits recognition of a loss on sale. If this was just a beginning of a long-term contract, I would analyse whether we're dealing with some kind of cost of obtaining a contract, but this is not the case here.

Telecoms faced a similar situation when IFRS 15 became effective. They used to give a customer a 'free' (or almost free) smartphone when the customer subscribed for a voice plan. The argued that this a marketing expense and not a real sale, but after IFRS 15 they need to treat is as a sale and the expense goes to COGS.

In the examiner's scenario, it is indeed odd to recognise a loss, but the transaction doesn't seem realistic too. But I guess his point was to treat the free bag as a marketing expense

[exIFRS]

Inventory must be recorded at lower of cost or sales value. You would need to impair inventory first.

[Marek Muc]

that's a good point!

another idea come to my mind - if that bag was purchased with that marketing campaign in mind, it shouldn't have been recognised as an asset in the first place:

https://ifrscommunity.com/knowledge-bas ... activities

[PrazFinPoint]

Free Goods given to customers, as part of a sale arrangement, is recorded as Trade Terms or Rebates to customers, under IFRS 15, which represents a deduction of the Gross Sales, and thus is recorded to Net Sales.

[Marek Muc]

So you would decrease revenue with the cost of the free gift? Which IFRS 15 paragraph are you applying here?

[exIFRS]

Remember a "free gift" still counts as a performance obligation, and therefore needs to be valued and recognised separately. https://ifrscommunity.com/knowledge-bas ... cognition/

See also: https://www.bdo.com.au/en-au/insights/r ... incentives

This is covered in the Basis of Conclusion (emphasis added):

BC88: Some respondents suggested that some promised goods or services should be excluded from the scope of IFRS 15 and accounted for as marketing expenses or incidental obligations, even though those promises would meet the definition of a performance obligation. Examples of such promised goods or services may include ‘free’ handsets provided by telecommunication entities, ‘free’ maintenance provided by automotive manufacturers and customer loyalty points awarded by supermarkets, airlines and hotels. Those respondents stated that revenue should be recognised only for the main goods or services for which the customer has contracted and not for what they consider to be marketing incentives and other incidental obligations.

BC89: The boards observed that when a customer contracts with an entity for a bundle of goods or services, it can be difficult and subjective for the entity to identify the main goods or services for which the customer has contracted. In addition, the outcome of that assessment could vary significantly depending on whether the entity performs the assessment from the perspective of its business model or from the perspective of the customer. Consequently, the boards decided that all goods or services promised to a customer as a result of a contract give rise to performance obligations because those promises were made as part of the negotiated exchange between the entity and its customer. Although the entity might consider those goods or services to be marketing incentives or incidental goods or services, they are goods or services for which the customer pays and to which the entity should allocate consideration for purposes of revenue recognition.

[marea]

IMIO the bag would be recognised as part of operating expenses and not of COGS.