Tangy Candy Company offers a coffee mug as a premium for every ten 50-peso candy bar

wrappers presented by customers together with P100.00. The purchase price of each mug to
the company is P90.00; in addition it costs P60.00 to mail each mug. The results of the
premium plan for the years 2019 and 2020 are as follows (assume all purchases and sales are
for cash):

2019 2020
Coffee mugs purchased 72,000 80,000
Candy bars sold 560,000 675,000
Wrappers redeemed 280,000 420,000
2019 wrappers expected to be 200,000
redeemed in 2020
2020 wrappers expected to be 270,000
redeemed in 2021

Instructions
(a) Prepare the general journal entries that should be made in 2019 and 2020 related to the
above plan by Tangy Candy.
(b) Indicate the account names, amounts, and classifications of the items related to the
premium plan that would appear on the Tangy Candy Company balance sheet and income
statement at the end of 2019 and 2020.

Solution 13-120

Cost of mug 90
Delivery cost 60
Less: cash paid (100)
Net premium expense 50

(a) 2019
Inventory of Premium Mugs............................................................. 6,480,000
Cash.................................................................................... 6,480,000
(72,000 × 90)

Cash................................................................................................ 28,000,000
Sales.................................................................................... 28,000,000
(560000 × 50)

Cash(net of mailing costs)............................................................... 1,120,000

Premium Expense........................................................................... 1,400,000
Inventory of Premium Mugs................................................. 2,520,000

Premium Expense........................................................................... 1,000,000

 Estimated Liability for Premiums.......................................... 1,000,000

2020
Inventory of Premium Mugs............................................................. 7,200,000
Cash ................................................................................... 7,200,000

Cash................................................................................................ 33,750,000
Sales.................................................................................... 33,750,000

Cash................................................................................................ 1,680,000
Estimated Liability for Premiums .................................................... 1,000,000
Premium Expense........................................................................... 1,100,000
Inventory of Premium Mugs ................................................ 3,780,000

Premium Expense........................................................................... 1,350,000

Estimated Liability for Premiums.......................................... 1,350,000

(b) Balance Sheet

Name Class 2019 2020
Inventory of Premium Mugs Current Asset 3,960,000 7,380,000
Estimated Liability for Premiums Current Liability 1,000,000 1,350,000

Income Statement
Name Class 2019 2020
Premium Expense Operating Expense 2,400,000 2,450,000
James Equipment Company sells computers for 150,000 each and also gives each customer a
2-year warranty that requires the company to perform periodic services and to replace defective
parts. During 2019, the company sold 70 computers. Based on past experience, the company
has estimated the total 2-year warranty costs as P3000 for parts and P6000 for labor. (Assume
sales all occur at December 31, 2019.)

In 2020, James incurred actual warranty costs relative to 2019 computer sales of 1,000,000 for
parts and 1,800,000 for labor.

Instructions
1. Under the accrual method, give the entries to reflect the above transactions for 2019 and
2020.
2. Under the cash method, give the entries to reflect the above transactions for 2019 and
2020.
3. Analyze and present the difference in incurrence of expense between the two methods.
(i.e., Warranty expense and Warranty liability balances)
4. Which method is more appropriate? Explain.
Accrual Basis (record the expense when the sale is consummated/matching principle) Dr. Cr.
2019
Accounts Receivable 10,050,000
Sales 10,050,000
To record Sale
Warranty Expense 630,000
Estimated Warranty Liability 630,000
To record accrual of warranty
2020
Estimated Warranty Liability 630,000
Warranty Expense 2,170,000
Inventory 1,000,000
Accrued Payroll 1,800,000
To record settlement on 2020
The estimate for 2019 was much lower (poorly
estimated) than the actual, so the excess is an
adjustment to warranty expense

Cash Basis/Expense as incurred approach Dr. Cr.

2019
Accounts Receivable 10,050,000
Sales 10,050,000
To record Sale
2020
Warranty Expense 2,800,000
Inventory 1,000,000
Accrued Payroll 1,800,000
To record settlement and incurrence of warranty
expense on 2020

Accrual Basis Cash Basis

Warranty expense (2019) 630,000 0

Warranty expense (2020) 2,170,000 2,800,000

Warranty Liability (2019) 630,000 0

Warranty Liability (2020) 0 0

Under GAAP, accrual method is more appropriate because it adheres to the matching principle
(match income over expenses).

A solid argument for use of cash basis is that it is better for tax purposes.