Assignment
Company Background
Stay Puft, Inc., is a small, family-owned business that manufactures and sells marshmallows to retailers throughout the United States. Stay Puft was founded during the Great Depression when Stanley Puft, founder of Stay Puft, realized that he could increase the size of foods by injecting them with air. Stay Puft remained in business with moderate sales growth through the end of the 20th century.
Shifting Winds
A confluence of several independent events in the early 2000s spelled trouble for the entire marshmallow industry. First, the rising fads of gourmet cupcakes and self-serve frozen yogurt meant that teens, tweens, and twentysomethings were less interested in snacking on bowls of marshmallows while out with friends. Second, the organic food trend, combined with rise of email use, led to an exponential increase in the number of email forwards warning of the dangers of refined sugar and processed foods. Third, the introduction of pre-made, pre-packaged Rice Krispies Treats reduced the demand for marshmallows as Kellogg's opted for a cheaper, glue-based recipe. Fourth, and perhaps most damaging, sales of marshmallow guns plummeted following a scathing exposé in Parents magazine.
Alternatives
As sales declined, Stay Puft began to search for ways to increase net income and operating cash flows. In particular, while Stay Puft's credit terms to customers had remained constant with payment due within 60 days of purchase, Stay Puft noted that customers had been delaying payments and for the first time some customers have defaulted on payments. This led Stay Puft to hire a part-time collections agent.
In November 2017, Stay Puft started considering alternative approaches for sales to its customers. Specifically, Stay Puft was considering a new cash-or-credit-card sales policy. This option would transfer the task of collections and the risk of nonpayment to credit card companies, although Stay Puft would pay a fee equal to 3% of credit card sales. To counteract the loss in profits the fee would entail, Stay Puft was also considering a second alternative that charges customers using credit cards the 3% fee.
To summarize, Stay Puft is considering the following three alternatives:
Current Policy:
- Customers have 60 days, interest free, to make payment on account
- Requires collections, and Stay Puft bears the risk of nonpayment
Cash-or-Card Policy:
- Customers can pay in cash or use a credit card
- Stay Puft pays a fee equal to 3% of credit card sales to credit card companies
- Stay Puft receives cash payment from credit card companies within 3-5 days of the sale
- Stay Puft does not engage in collections and bears no risk of nonpayment
Cash-or-Card Policy with Fee:
- Similar to the cash-or-card policy, but customers using a credit card pay an additional 3% to Stay Puft
- The additional fee could result in a decline in sales
Stay Puft estimates the following results for the first quarter of 2018 under the three alternatives:
Current Policy Cash or Card Cash or Card w/Fee
Total Sales $500,000 $500,000 $485,000
Cash Sales $200,000 $100,000 $300,000
Credit Card Sales - $400,000 $185,000
Sales on $300,000 - -
Account (A/R)
Uncollectible 5% of credit sales - -
Accounts
Cost of Collections $5,000 - -
Finally, based on conversations with Stay Puft employees, you learned the following:
- Sales returns are not permitted
- Stay Puft uses the percentage-of-sales approach to estimate Bad Debt Expense
- The Total Sales estimates above exclude any credit card fees
- Ancient Egyptians produced and ate marshmallows 4,000 years ago
Required
Stay Puft has hired you, an accounting consultant, to outline the potential effects of the new sales policies under consideration and recommend one of the alternatives. Write a one- to two-page memo (double space) summarizing your analysis and recommendation, along with the basis for that recommendation.
- Focus your memo on the effects of the current and new policies on revenues, expenses, net income, and operating cash flows
- It may be helpful to include a chart summarizing the effects of the three alternatives side by side
- Stay Puft is particularly interested in your explanation of the accounting for credit card fees. Would revenue be recognized including or net of the 3% fee paid to the credit card companies? Does this classification of the fee depend on whether Stay Puft charges the fee back to the customer?
- Include the basis for your conclusions and recommendation
- For example, you might point to specific GAAP guidance on credit card fees (if there is any), GAAP guidance on revenue transaction prices, or make analogies to other GAAP guidance (e.g., factoring accounts receivable, gross vs. net revenue recognition)
- If you don't believe there is enough information to make a recommendation, then include a request for specific additional information, and tentative recommendations based on possible responses.