Pcoa 008 - Intermediate Accounting Ii Learning Outcomes

MODULE 2
PCOA 008 – INTERMEDIATE ACCOUNTING II

Learning Outcomes:
At the end of this module, you are expected to have recognized and measured:
 premium liability
 cash rebate program
 cash discount offer program.
 customer loyalty program.
 estimated warranty liability
PREMIUMS
The accounting procedures for the acquisition of premiums and recognition of the premium
liability are as follows:
1. When premiums are purchased:
Premiums xxx
Cash xxx
2. When premiums are distributed to customers:
Premium expense xxx
Premiums xxx
3. At the end of the year, if premiums are still outstanding:
Premium expense xxx
Estimated premium liability xxx
THIS MODULE IS FOR THE EXCLUSIVE USE OF THE UNIVERSITY OF LA SALETTE, INC. ANY FORM OF REPRODUCTION, DISTRIBUTION,
UPLOADING, OR POSTING ONLINE IN ANY FORM OR BY ANY MEANS WITHOUT THE WRITTEN PERMISSION OF THE UNIVERSITY IS
STRICTLY PROHIBITED.
1
Illustration:
An entity manufactures a certain product and sells it at P300 per unit.
A soup bowl is offered to customers on the return of 5 wrappers plus a remittance of P10.
The bowl costs P50, and it is estimated that 60% of the wrappers will be redeemed.
The data for the first year concerning the premium plan are summarized below:
Sales, 10,000 units at P300 each 3,000,000
Soup bowls purchased, 2000 units at P50 each 100,000
Wrappers redeemed 4,000
The entries that would be made in the first year to record the sales, premium purchases and
redemption, and year-end adjustments are:
1. To record the sales:
Cash 3,000,000
Sales 3,000,000
2. To record the purchase of premiums:
Premiums 100,000
Cash 100,000
3. To record the redemption of 4,000 wrappers:
Cash (800 x 10) 8,000

Premium expense (800 x 40) 32,000
Premiums 40,000
4. To record the liability for the premiums at the end of the first year:
Premium expense 16,000

Estimated premium liability 16,000
2
Computation:
Wrappers to be redeemed (60% x 10,000 wrappers) 6,000
Less: wrappers redeemed 4,000
Balance 2,000
Premiums to be distributed (2000/5) 400
Financial liability (400 x 40) 16,000
Financial statement classification

At the end of the year, the accounts related to the premium plan are as follows:
Current Asset:
Premiums 60,000
Current Liability:
Estimated premium liability 16,000
Distribution cost:
Premium Expense 48,000
3
CASH REBATE PROGRAM
A variation of a premium offer is a cash rebate program which has become common place.
Cash register receipts, bar-codes, rebate coupons, and other proof of purchase often can be mailed
to the manufacturer for cash rebate.
Like any premiums offer, the purpose of the cash rebate program is to stimulate sales.
Accordingly, the estimated amount of the cash rebate should be recognized both as an expense and
an estimated liability in the period of sale.
Illustration:
An entity offered P500 cash rebate on a particular model set. The customers must present a rebate
coupon enclosed in every package sold plus the official receipt.
Past experience indicates that 40% of the coupons will be redeemed.
During the current year, the entity sold 4,000 units of TV sets and total payments to customers
amounted to P450,000.
1. To recognize the cash rebate program:
Rebate expense 800,000
Estimated rebate liability 800,000.
Rebate coupons issued 4000

Expected to be redeemed x 40%
Coupons to be redeemed 1600
Cash rebate per coupon x 500
Estimated rebate liability 800,000
2. To record customer payments:
Estimated rebate liability 450,000

Cash 450,000
4
CASH DISCOUNT COUPON
Another variation of the premium is the cash discount coupon program.
The cash discount program is a popular marketing tool for the purpose of stimulating sales.
Like a premium offer and cash rebate program, an expense and an estimated liability for the
expected cash discount should be recognized in the period of sale.
Illustration:
During the current year, an entity inserted in each package sold a coupon offering P300 off the
purchase price of a particular brand of product when the coupon is presented to retailers.
The retailers are reimbursed for the face amount of coupons plus 10% for handling. Previous
experience indicates that 30% of coupons will be redeemed.
During the current year, the entity issued coupons with face amount of P5,000,000 and total
payments to retailers amounted to P1,100,000.
1. To recognize cash discount coupon offer:
Cash discount coupon expense 1,650,000
Estimated coupon liability 1,650,000
Face amount of coupons to be redeemed

(30% x 5,000,000) 1,500,000
Multiply by (100% face plus 10% handling) 110%
1,650,000
2. To record payments to retailers:

Estimated coupon liability 1,100,000
Cash 1,100,000
5
CUSTOMERS LOYALTY PROGRAM
Many entities use a customer loyalty program to build brand loyalty, retain their valuable
customers and of course, increase sales volume.
The customer loyalty program is generally designed to reward customers for past purchases and
to provide them with incentives to make further purchases.
If a customer buys goods or services, the entity grants the customer award credits often described
as “points”.
The entity can redeem the “points” by distributing to the customer free or discounted goods or
services.
A customer loyalty program operates in a variety of ways.
Customers may be required to accumulate a specified minimum number of award credits or
“points” before they can be redeemed.
Measurement
An entity shall account for the award credits as a separately component of the initial sale
transaction.
In other words, the granting of award credits is effectively accounted for as a future delivery of
goods or services.
IFRS 15, paragraph 74, provides that an entity shall allocate the transaction price to each
performance obligation identified in a contract on a relative stand-alone selling price basis.
In other words, the fair value of the consideration received with respect to the initial sale shall be
allocated between the award credits and the sale based on relative stand-alone selling price.
The stand-alone selling price is the price at which an entity would sell a promised good or service
separately to a customer.
Recognition
The consideration allocated to the award credits is initially recognized as deferred revenue and
subsequently recognized as revenue when the award credits are redeemed.
The amount of revenue recognized shall be based on the number of award credits that have been
redeemed relative the total number expected to be redeemed.
The estimated redemption rate is assessed each period. Changes in the total number of expected to
be redeemed do not affect the total consideration for the award credits.
6
Instead, the changes in the total number of award credits expected to be redeemed shall be reflected
in the amount of revenue recognized in the current and future periods.
In other words, the calculation of revenue to be recognized in any one period is made on a
“cumulative basis” in order to reflect the changes in estimate.
Illustration:
An entity, a grocery retailer, operates a customer loyalty program.
The entity grants program members loyalty points when they spend a specified amount of
groceries.
Program members can redeem the points for further groceries. The points have no expiry date.
The sales during 2020 amounted to P9,000,000 based on stand-alone selling price.
During 2020, the customers earned 10,000 points.
But management expects that 80% or 8,000 of these points will be redeemed.
The stand-alone selling price of each loyalty point is P100.
On December 31, 2020 4,000 points have been redeemed in exchange for groceries.
In 2021, management revised expectations and now expects that 90% or 9,000 points will be
redeemed altogether
During 2021, the entity redeemed 4,100 points. In 2022, a further 900 points are redeemed.
Management continues to expect that only 9,000 points will ever be redeemed, meaning, no more
points will be redeemed after 2022.
Allocations of transaction price
Product sales 9,000,000
Points – stand-alone selling price
(10,000 x 100) 1,000,000
Total 10,000,000
Product sales 8,100,000

Points 900,000
Total transaction price 9,000,000
7
Journal entries
The initial sale in 2020 is recorded as follows:
Cash 9,000,000
Sales 8,100,000
Unearned revenue – points 900,000
Redemption of 4,000 points in 2020

Sales 450,000
Revenue to be recognized in 2020 450,000

(4,000/8,000 x 900,000)
Redemption of 4,100 points in 2021:

Sales 360,000
Points redeemed in 2020 4,000

Total points redeemed to December 31, 2021 8,100
Cumulative revenue on December 31, 2021

(8,100 / 9,000 x 900,000) 810,000
Revenue recognized in 2020 (450,000)
8
Redemption of 900 points in 2022

Sales 90,000

Points redeemed in 2022 900
Total points redeemed to December 31, 2022 9,000
Cumulative revenue on December 31, 2022

(9,000 / 9,000 x 900,000) 900,000
Cumulative revenue recognized in 2021 (810,000)
Third party operates loyalty program

An entity, a retailer of electrical goods, participates in a customer loyalty program operated by an
airline.
The entity grants program members one air travel point for every P1,000 spent on electrical goods.
Program members can redeem the points for travel with the airline subject to availability. The
entity pays the airline P60 for each point.
During the current year, the entity sold electrical goods for consideration totaling P4,500,000 based
on stand-alone selling price and granted 5,000 points with stand-alone selling price of P100 per
point.
Selling price Fraction Allocated
Product sales 4,500,000 45/50 4,050,000

Points 500,000 5/50 450,000
5,000,000 4,500,000
Revenue from points 450,000

Payments to airline (5,000 x 60) (300,000)
Net revenue from points 150,000
The entity has fulfilled its obligation by granting the points.
Therefore, revenue from points is recognized when the electrical goods are sold.
9
To record the initial sale:
Cash 4,500,000
Sales 4,050,000
Revenue from points 450,000
To record payment to airline
Loyalty program expense 300,000

Cash 300,000
WARRANTY
Home appliances like television sets, stereo sets, refrigerators, and the like are often sold under
guarantee or warranty to provide free repair service or replacement during a specified period if the
products are defective.
Such entity policy may involve significant costs of the part of the entity if the products sold prove to
be defective in the future within the specified period of time.
Recognition of warranty provision
PAS 37, paragraph 14, provides that a provision shall be recognized as liability in the financial
statement under the following conditions:
a. The entity has a present obligation, legal or constructive, as a result of past event.
It is probable that an outflow of resources embodying economic benefits would be
b. required to settle the obligation.
c. The amount of the obligation can be measured reliably.
Past event
The past event, often referred to as the obligating event, must have occurred.
The obligating event in this case is the sale of the product which gives rise to a constructive
obligation.
10
Probable outflow resources
The warranty results in an outflow of resources embodying economic benefit in settlement.
It is probable that there will be some claims against the warranty.
Reliable estimate
The amount recognized as the warranty provision should be the best estimate of the expenditure to
settle the present obligation.
Where no reliable estimate can be made, no warranty liability is recognized.
Accounting for warranty
There are two approaches in recording the warranty expense, namely:

a. Accrual approach
b. Expense as incurred approach
Accrual approach
The accrual approach has the soundest theoretical support because it properly matches cost with
revenue.
Following this approach, the estimated warranty cost is recorded as follows:
Warranty expense xxx

Estimated warranty liability xxx
When actual warranty cost is subsequently incurred and paid, the entry is:

Cash xxx
At a certain date, the estimated is reviewed to determine its reasonableness and accuracy. The actual
warranty cost is analyzed to validate the original estimate.
Any difference between estimate and actual cost is a change in estimate and therefore treated
currently or prospectively, if necessary.
11
Thus, if the actual cost exceeds the estimate, the difference is charged to warranty expense as
follows:

If the actual cost is less than the estimate, the difference is an adjustment to warranty expense as
follows:

Illustration:
An entity sells 1,000 units of television sets at P9,000 each for cash. Each television set is under
warranty for one year.
The entity has estimated from past experience that warranty cost will probably average P500 per unit
and that only 60% of the units sold will be returned for repair.
The entity incurs P180,000 for repairs during the year.
Journal entries
Cash 9,000,000
Sales 9,000,000
2. To set up the estimated liability on the warranty:
Warranty expense 300,000

Estimated warranty liability 300,000
Estimated sets to be returned (60% x 1,000) 600

Multiply by estimated warranty cost per set 500
Estimated warranty cost 300,000
3. To record the payment of the actual cost:

Cash 180,000
12
The statement of financial position at the end of the year would report estimated warranty liability of
P120,000 as a current liability.
The income statement for the year would show warranty expense of P300,000
If the warranty runs over a period of more than one year, a portion of the estimated warranty liability
shall be reported as current liability and the remaining portion as noncurrent liability.
In other words, the warranty cost expected to be incurred within one year is classified as current and
the balance as noncurrent.
Expense as incurred approach
The expense as incurred approach is the approach of expensing warranty cost only when actually
incurred.
This approach is justified on the basis of expediency when warranty cost is not very substantial or
when the warranty period is relatively short.
The actual warranty cost of P180,000 is simply recorded by debiting warranty expense and crediting
cash.
13
Another illustration
An entity sells refrigerators that carry a 2-year warranty against defects. The sales and warranty
repairs are made evenly throughout the year.
Based on past experience, the entity projects an estimated warranty cost as a percentage of sales as
follows:
First year of warranty 4%

Second year of warranty 10%
2020 2021
Sales 5,000,000 6,000,000

Actual warranty repairs 140,000 300,000
Journal Entries
2020
Cash 5,000,000
Sales 5,000,000
2. To record the warranty expense:

(14% x 5,000,000)
Note that the total warranty expense each year is 14% to be incurred over a 2-year
warranty period.
3. To record the actual warranty repairs:

Cash 140,000
2021
Cash 6,000,000
Sales 6,000,000
14
2. To record the warranty expense:

Estimate warranty liability 840,000
(14% x 6,000,000)
3. To record the actual warranty repairs:

Cash 300,000
At this point, on December 31, 2021, the estimated warranty liability is P1,100,000.
Warranty expense:
2020 700,000
2021 840,000 1,540,000
Actual warranty repairs:
2020 140,000
2021 300,000 440,000
Estimated warranty liability - December 31, 2021 1,100,000
15
Testing the accuracy of warranty liability
On December 31, 2021, the estimated warranty liability account may be analyzed based on the 4%
and 10% estimate to determine whether the actual warranty costs approximate the estimate.
Sales made evenly

To have an easier interpretation or understanding of sales accruing evenly during the year, it is fair
to assume that half of the sales were made on January 1 and the other half on July 1
Thus, the first contract under a 2-year warranty of the sales made on January 1, 2020 will be within
January 1, 2020 to December 31, 2020, and the second contract year will be within January 1, 2021
to December 31, 2021.
The first contract year under a 2-year warranty of the sales made on July 1, 2020 will be within July
1, 2020 to June 30, 2021, and the second contract year will be July 1, 2021 to June 30, 2022
Computations
Warranty expense related to 2020 sales

2020
First contract year of January 1, 2020 sales
(2,500,000 x 4%) 100,000
First contract year of July 1, 2020 sales
(2,500,000 x 4%x6/12) 50,000
2021
(2,500,000 x 4%x6/12) 50,000
Second contract year of January 1, 2020 sales
(2,500,000 x 10%) 250,000
Second contract year of July 1, 2020 sales
(2,500,000 x 10%x6/12) 125,000
2022
(2,500,000 x 10%x6/12) 125,000
700,000
16
Warranty expense related to 2021 sales
2021
First contract year of January 1, 2020 sales
(3,000,000 x
4%) 120,000
(3,000,000 x 4%x6/12) 60,000
2022
(3,000,000 x 4%x6/12) 60,000
Second contract year of January 1, 2020 sales
(3,000,000 x 10%) 300,000
(3,000,000 x 10%x6/12) 150,000
2023
(3,000,000 x 10%x6/12) 150,000
840,000
17
The warranty costs after December 31, 2021 represent the estimated warranty liability on December
31, 2021.
2020 sales still under warranty after December 31, 2021:
Second contract year of July 1, 2020 sales 125,000
2021 sales still under warranty after December 31, 2021:
First contract year of July 1, 2021 sales 60,000
Second contract year of January 1, 2021 sales 300,000

(150,000+150,000)
300,000
Estimated warranty liability - December 31, 2021 785,000
Estimated warranty liability per book

1,100,000
Decrease in warranty liability (315,000)
The decrease in warranty liability is an adjustment of the warranty expense of 2021.

18
Sale warranty
A warranty is sometimes sold separately from the product sold.
When products are sold, the customers are entitled to the usual manufacturer's warranty during a
certain period.
However, the seller may offer an "extended warranty" on the product sold but with additional cost.
In such a cash, the sale of product with the usual warranty is recorded separately from the sale of
extended warranty.
The amount received from the sale of the extended warranty is recognized initially as deferred
revenue and subsequently amortized using straight line over the life of the warranty contract.
However, if costs are expected to be incurred in performing services under the extended warranty
contract, revenue is recognized in proportion to the costs to be incurred annually.
Illustration
An entity sold a product for P3,000,000. The regular warranty period for the product is two years.
The entity sold an additional warranty of two years at a cost of P60,000.
The sale is recorded as:

Cash 3,060,000
Sales 60,000
Unearned warranty revenue 3,000,000
The extended warranty contract starts only after the expiration of the regular two-year warranty
period.
If the costs are incurred evenly, the unearned warranty revenue is amortized at the end of the third
year as:
Unearned warranty revenue 30,000

Warranty revenue (60,000 / 2) 30,000
REFERENCE:
Valix, C. T., Peralta, J. F., & Valix, C. A. M. (2020). Intermediate Accounting (Vol. 2).
GIC Enterprises & Co., Inc.
19

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MODULE 2

PCOA 008 – INTERMEDIATE ACCOUNTING II

2. To record the purchase of premiums:

3. To record the redemption of 4,000 wrappers:

Cash (800 x 10) 8,000

Premium expense 16,000

Financial statement classification

Rebate coupons issued 4000

2. To record customer payments:

Estimated rebate liability 450,000

Face amount of coupons to be redeemed

2. To record payments to retailers:

Product sales 8,100,000

Redemption of 4,000 points in 2020

Unearned revenue – points 450,000

Revenue to be recognized in 2020 450,000

Redemption of 4,100 points in 2021:

Unearned revenue – points 360,000

Points redeemed in 2020 4,000

Cumulative revenue on December 31, 2021

Unearned revenue – points 90,000

Points redeemed in 2020 4,000

Cumulative revenue on December 31, 2022

Third party operates loyalty program

Product sales 4,500,000 45/50 4,050,000

Revenue from points 450,000

To record payment to airline

Loyalty program expense 300,000

Recognition of warranty provision

The warranty results in an outflow of resources embodying economic benefit in settlement.

It is probable that there will be some claims against the warranty.

Where no reliable estimate can be made, no warranty liability is recognized.

Accounting for warranty

There are two approaches in recording the warranty expense, namely:

Following this approach, the estimated warranty cost is recorded as follows:

Warranty expense xxx

Estimated warranty liability xxx

Warranty expense xxx

Estimated warranty liability xxx

The entity incurs P180,000 for repairs during the year.

2. To set up the estimated liability on the warranty:

Warranty expense 300,000

Estimated sets to be returned (60% x 1,000) 600

3. To record the payment of the actual cost:

Expense as incurred approach

First year of warranty 4%

Sales 5,000,000 6,000,000

2. To record the warranty expense:

Warranty expense 700,000

3. To record the actual warranty repairs:

Estimated warranty liability 140,000

Warranty expense 840,000

3. To record the actual warranty repairs:

Estimated warranty liability 300,000

2021 840,000 1,540,000

Actual warranty repairs:

2021 300,000 440,000

Estimated warranty liability - December 31, 2021 1,100,000

Sales made evenly

Warranty expense related to 2020 sales

2020 sales still under warranty after December 31, 2021:

Second contract year of July 1, 2020 sales 125,000

2021 sales still under warranty after December 31, 2021: