Question

Hawaii Fitness Club, Inc. is a publicly traded company that operates 750 discount retail stores in forty-four states nationwide. Hawaii Fitness generates its revenue from both a membership fee charged to its customers and the sale of merchandise at discount retail prices. Hawaii Fitness has been in business for over 25 years, and offers its customers the following service: low prices on a limited selection of branded and private-label products in a broad range of merchandise categories. Customers pay a membership fee for the right to shop at Hawaii Fitness and purchase products at discounted prices. Hawaii Fitness has a two-tiered membership fee structure. A two-year annual membership fee of $150 is charged to all new customers. After the first two years, a one-year annual membership fee of $50 continues to be charged. To reward customers for their long-term loyalty, no membership fee is charged after being a member for ten years. All fees are required to be paid at the beginning of the membership period. In order to encourage new members to join and old customers to renew their memberships, Hawaii Fitness has a full refund policy of the entire membership fee at any time during the first year of the membership period, even if the member cancels on the very last day. This refund policy has been in existence for many years and, during that time, Hawaii Fitness has experienced the following refund results. For the last five years, 30% of the 2-year members and 10% of the one-year members requested refunds. Hawaii Fitness has not experienced and does not anticipate estimated refunds being materially different from actual refunds. Due to the enormous popularity of the stores, Hawaii Fitness has averaged in excess of 10,000 new member customers nationwide each year for the last three years. It is Hawaii Fitness’s accounting practice to recognize the entire fee as revenue at the beginning of each membership period. The new CEO, Ella Mentry, wants assurances that Hawaii Fitness’s membership revenue recognition complies with U.S. GAAP in order for her to certify the financial statements in accordance with Section 302 of the Sarbanes-Oxley Act.

Analyze steps 1 through 3 of the revenue recognition model, i.e. identify the contract, identify the performance obligations, and determine the transaction price. Make sure to address, among the other issues, how the variable consideration issues should be treated.

Answer 1

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