Question

Sit-up Fitness (SFC) is a new athletic facility, located in Saskatoon, Saskatchewan. SFC is owned and operated by Calvin Power, a former Olympic gold medallist in weightlifting. Calvin decided to make his pas­ sion his business by opening open a local gym. SFC has the following mission statement:

“SFC provides the residents of Saskatoon the opportunity to live a healthier, happier, and longer life by providing affordable access to athletic equipment, aerobic classes, and specialized dieticians.”

Calvin borrowed $10 million from the bank in order to finance the required start-up investments in working capital and capital assets. Calvin invested $2 million of his own money (that he earned through his career as a weightlifter and professional wrestler). The bank does not want the debt to equity ratio to exceed 5:1.

The first year of business has been a bit a rocky, as Calvin’s expertise is in weight training, as opposed to running a business. However, SFC was able to attract 5,000 people to purchase full memberships.

It was difficult to attract new members during the first few months of operations. In order to attract more members, Calvin implemented the following creative marketing initiatives during the middle of the year:

»             Power Points – SFC offers its members 1 point per visit to the gym (maximum of 1 point per day). Power Points can be redeemed for free passes for a guest or for a free protein drink.

»             Initial Fee Return Guarantee – For three months, SFC provided new members with a guarantee period whereby their initial membership fee could be returned if they decide to discontinue their membership within the first year.

»             Free Membership Challenge – Members are entered into a draw every time they access the gym, and provided with a chance to win free membership fees for life.

Calvin has come to you, Badami and Lusamba LLP, for assistance regarding the preparation of the December 31 year-end financial statements in accordance with ASPE. Calvin knows how much cash came in from memberships, but is unsure about how much revenue should be recognized. In addition, Calvin needs help understanding how the marketing initiatives impact the financial statement. Additional details on the marketing initiatives can be found in Exhibit I, which outlines your most recent discussion with Calvin.

Required

Prepare a report that addresses Calvin’s concerns. The partner would like you to do a good job on this engagement as it may lead to more work, and the annual year-end audit. Therefore, the partner has asked you to prepare any journal entries to record your recommended accounting treatments.

EXIBIT I – DISCUSSION WITH CALVIN POWER

Memberships require a non-refundable $500 initiation fee, followed by a monthly fee of $50. The monthly fee must be paid at the beginning of each month. The following is a monthly breakdown of the new memberships.

Jan	Feb	Mar	April	May	June	July	Aug	Sept	Oct	Nov	Dec
200	250	350	200	250	400	850	900	800	300	300	200

SFC offered new members an initial fee return guarantee during the months of July, August, and September. The program was well received, and resulted in significant increases in membership. Calvin believes the program is so successful because it provides people with a risk-free opportunity to see what SFC has to offer. Calvin is confident that once a member has a chance to work out at the gym, and take advantage of all it has to offer, no one will discontinue their membership. As of December 31, not a single person has taken advantage of the initial fee return guarantee. Revenue has been recorded on a cash basis by Calvin.

The Power Points can be redeemed as follows:

•             A total of 10 Power Points can be redeemed for a free pass for a guest. With a free pass, a mem­ ber can bring a guest into the gym to use all of the facilities for free. The only condition is that a free-pass guest cannot partake in any aerobic classes if they are full (i.e., they cannot bump out a paying customer). Anyone can purchase a day pass to SFC for $5, which will entitle them to full access to the gym, including all classes.

•             A total of 15 Power Points can be redeemed for a free protein shake. The shake can be purchased from SFC for $6.50. It costs SFC a total of $2.50, including all overhead allocations, to prepare the shake.

During the year, a total of 30,255 Power Points were issued. Members took favourably to this pro­ motion; the Points were redeemed for 60 free guest passes and 75 free protein shakes. Industry standards suggest that a total of 20% of all Points will not be redeemed. The only journal entries recorded in regards to the Power Points was a debit to cost of goods sold and credit to inventory for the protein shakes.

Every time a member swipes their membership card to access the gym, they are electronically entered into a random draw. The winner of the draw will then have a chance to win a free membership for life. In order to win the challenge, the member must do more push-ups than Calvin. The draw will take place on February 5 of the following fiscal year, and the push-up challenge will take place on February 25.

Answer 1

Financial Impact for Sit-up Fitness Centre, would be analysed based on the above transactions made by Calvin. For a better understanding of the scope, some of the journal entries would be:

A sum of money borrowed from the bank ($10 million) is shown as a liability in his books. Therefore, journal would be:

Bank A/C Dr $10M

To loan A/c Cr $10M

(Being amount borrowed from the bank for investment purpose for a start-up)

Next, $2 million money of Calvin not recorded because it was invested for his professional training with his own money.

In order to calculate the revenue for Calvin's business, the below steps needs to be followed:

No of customers*average price of services, which is, 5000 = no of customers and the membership cost = Monthly is Rs 5000.

No of customers*Average price of services, which is 5000*$415 = 5000*$415, which is

$2075000. Therefore, revenue earned is $2075000.