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!

 

[StanleyR1]

An alternative entry would be

Dr Cash: $5
Cr Revenue: $5
Dr COGS: $2
Dr Advertising & promotion: $6
Cr Inventory: $8

 

[sgaccountant]

Thanks for your reply Stanley!

May I understand why is it okay to charge it to advertising & promotion?

I've tried to do some digging but based on the resources online they seem to hint that they should be charged to COGS instead of marketing.

Thanks for your advice!

https://www.pwc.com/gx/en/audit-services/ifrs/publications/ifrs-15/ifrs-news%20feb-2017-mole-article.pdf

Gated Content

 

[StanleyR1]

I used Advertising and Promotion because the free apples were given as an incentive for the customer to return and to generate positive word-of-mouth. In my entry, the cost of the advertising was the cost of the apples.

It's likely, however, that your interviewer was looking for a slightly different answer. Consider that the cost of one apple is $2 and it sells for $5. A bag of apples costing $6 would likely sell for $15, assuming the same markup and no volume discount.

The seller would then record a $20 sale (credit Revenue) with a $15 discount (debit Discounts or Advertising and Promotion), netting $5 in cash. You would still debit COGS and credit Inventory for $8, but now your COGS is less than Revenue ($20).

The difference is that in my entry above, Advertising and Promotion represented the cost of free goods, where in this example it represents lost revenue. Both methods are acceptable. The key is that you want to recognize and account for the discounts.

 

[Praz Finpoint]

Under IFRS 15 - free goods given to customers, as part of a sales transaction, are recorded as Trade Support or Rebates in Profit & Loss which is a deduction of Gross Sales; so reduction to Net Sales essentially.

 

[Zer0tax]

An alternative entry would be

Dr Cash: $5
Cr Revenue: $5
Dr COGS: $2
Dr Advertising & promotion: $6
Cr Inventory: $8

I think both answers given here are good. I would charge COGS. You could charge Advertising & Promotion. Both are acceptable. Really not all that unusual for COGS to be > Sales. It is undesirable but not uncommon.