Cutting Edge is a monthly magazine that has been on themarket for 18 months....

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Accounting

Cutting Edge is a monthly magazine that has been on themarket for 18 months. It currently has a circulation of 1.4 millioncopies. Negotiations are underway to obtain a bank loan in order toupdate the magazine's facilities. Cutting Edge isproducing close to capacity and expects to grow at an average of20% per year over the next 3 years.
After reviewing the financial statements of CuttingEdge, Andy Rich, the bank loan officer, had indicated that aloan could be offered to Cutting Edge only if it couldincrease its current ratio and decrease its debt to equity ratio toa specified level. Jonathan Embry, the marketing manager ofCutting Edge, has devised a plan to meet theserequirements. Embry indicates that an advertising campaign can beinitiated to immediately increase circulation. The potentialcustomers would be contacted after the purchase of anothermagazine's mailing list. The campaign would include:
1.An offer to subscribe to CuttingEdge at three-fourths the normal price.
2.A special offer to all new subscribers toreceive the most current world atlas whenever requested at aguaranteed price of $2.
3.An unconditional guarantee that anysubscriber will receive a full refund if dissatisfied with themagazine.
Although the offer of a full refund is risky, Embry claims thatfew people will ask for a refund after receiving half of theirsubscription issues. Embry notes that other magazine companies havetried this sales promotion technique and experienced great success.Their average cancellation rate was 25%. On average, each companyincreased its initial circulation threefold and in the long runincreased circulation to twice that which existed before thepromotion. In addition, 60% of the new subscribers are expected totake advantage of the atlas premium. Embry feels confident that theincreased subscriptions from the advertising campaign will increasethe current ratio and decrease the debt to equity ratio.
You are the controller of Cutting Edge and must giveyour opinion of the proposed plan.
Instructions
(a)When should revenue from the newsubscriptions be recognized?
(b)How would you classify the estimated salesreturns stemming from the unconditional guarantee?
(c)How should the atlas premium be recorded? Isthe estimated premium claims a liability? Explain.
(d)Does the proposed plan achieve the goals ofincreasing the current ratio and decreasing the debt to equityratio?

Answer & Explanation Solved by verified expert

3.8 Ratings (545 Votes)

a The revenue from the news subscriptions can only be recognized once it is earned The revenue recognition principle states that under the accrual basis of accounting you should only record revenue See Answer

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In: AccountingCutting Edge is a monthly magazine that has been on themarket for 18 months. It...Cutting Edge is a monthly magazine that has been on themarket for 18 months. It currently has a circulation of 1.4 millioncopies. Negotiations are underway to obtain a bank loan in order toupdate the magazine's facilities. Cutting Edge isproducing close to capacity and expects to grow at an average of20% per year over the next 3 years.After reviewing the financial statements of CuttingEdge, Andy Rich, the bank loan officer, had indicated that aloan could be offered to Cutting Edge only if it couldincrease its current ratio and decrease its debt to equity ratio toa specified level. Jonathan Embry, the marketing manager ofCutting Edge, has devised a plan to meet theserequirements. Embry indicates that an advertising campaign can beinitiated to immediately increase circulation. The potentialcustomers would be contacted after the purchase of anothermagazine's mailing list. The campaign would include:1.An offer to subscribe to CuttingEdge at three-fourths the normal price.2.A special offer to all new subscribers toreceive the most current world atlas whenever requested at aguaranteed price of $2.3.An unconditional guarantee that anysubscriber will receive a full refund if dissatisfied with themagazine.Although the offer of a full refund is risky, Embry claims thatfew people will ask for a refund after receiving half of theirsubscription issues. Embry notes that other magazine companies havetried this sales promotion technique and experienced great success.Their average cancellation rate was 25%. On average, each companyincreased its initial circulation threefold and in the long runincreased circulation to twice that which existed before thepromotion. In addition, 60% of the new subscribers are expected totake advantage of the atlas premium. Embry feels confident that theincreased subscriptions from the advertising campaign will increasethe current ratio and decrease the debt to equity ratio.You are the controller of Cutting Edge and must giveyour opinion of the proposed plan.Instructions(a)When should revenue from the newsubscriptions be recognized?(b)How would you classify the estimated salesreturns stemming from the unconditional guarantee?(c)How should the atlas premium be recorded? Isthe estimated premium claims a liability? Explain.(d)Does the proposed plan achieve the goals ofincreasing the current ratio and decreasing the debt to equityratio?