Premiums

and
Warranties
 ESTIMATED LIABILITIES

Refers to obligations existing at the end of the reporting

period but the amount of which is not definite. Many times
also, the payee is not exactly identified. It is presented
2
either current or non- current in nature.

Examples include: Premium, award points, warranties, gift

certificates and Bonus.
 PREMIUMS LIABILITY
It is a type of liability that arises from a company offering premiums to
their customer in order to increase the sale of their products. Hence
accounting consideration involves the purchase of premiums, recording
of the premium expense and the premium liability at the end of the
accounting period. 3

PREMIUMS – items of value such as toy, mugs, soup bowls, T-shirts

and the like which are purchased by the company for its promotional
campaign in an effort to increase sales are recorded at cost of
purchase and is presented among current assets of the company in its
statement of financial position.
ENTRIES:

To record purchase of premiums

Premiums xx
Cash xx

To record distribution of premiums to customers

Premiums expense xx 4
Premiums xx

To record premiums outstanding at year-end

Premiums expense xx
Estimated premium liability xx
EXAMPLE

Faith company is a manufacturer of a certain product which its sell for

150 per unit. A soup bowl is offered to customers in return of 5
wrappers plus a remittance of 5. The bowl costs 25 each and 60% of
wrappers is estimated to be redeemed. The presentation of premiums
which are items of value is a current asset. Premium expense is
5
reported in the income statement while the estimated premiums liability
is among its current liabilities in the statement of financial position. The
data for the current year appears as follows:

Sales 10,000units year 1, 15000 year 2 at 150 each 1,500,000

Soup bowl purchased, 2,000 units at 25 each 50,000

Wrappers redeemed 4,000

ENTRIES

Cash 1,500,000
Sales 1,500,000

Premiums – soup bowl 50,000

Cash 50,000
6
Cash (4T/5*5) 4,000
Premium expense (800*20) 16,000
Premium-soup bowl (800*20) 20,000

Premium expense 8,000

Est. premium liability 8,000

10,000*60% = 6,000/5 = 1,200 – 800 = 400*20 = 8,000

 CUSTOMER LOYALTY
PROGRAM
• Is generally designed by companies to reward their customers
for past purchases by providing them incentives or discounted
goods and services.
7

• Award credits often called as “points” are given to customers

as they buy goods and services of the company.

• The incentives to customers involve future delivery of goods.

IFRIC 13 provides for the measurement of the award credits. It
states that the fair value of the consideration received from the
initial sale is allocated between the award credits and the sale on
the basis of a relative stand-alone selling price.
8
Stand-alone selling price – the price at which an entity would sell
a promised good or service separately to a customer
EXAMPLE

An entity that operates a customer loyalty program grants members loyalty

points redeemable for further groceries. The sales during 2020 amounted to
9,000,000 based on a stand-alone selling price.

During 2020, customers earned 10,000 but only 80% of this is estimated by
the company to be redeemed. The stand-alone selling price of each loyalty 9
points is estimated at 100. On Dec. 31, 2020, 4,000 points have been
redeemed. In 2020, the revised management expectation is now 90% or
9,000 points altogether.

During 2021, the entity redeemed 4,100 points. In 2022, additional 900
points are redeemed. Management continues to expect that 9,000 points
will ever be redeemed.
ENTRIES

Allocate:

Sales 9M 9/108,100T
Points (10T*100) 1M 1/10900T
Total 10M 9,000T
10

Cash 9,000,000
Sales 8,100,000
Unearned revenue – points 900,000
To initially record sale
ENTRIES

2020 Unearned revenue – points (4T/8T*900T) 450,000

Sale 450,000

2021 Unearned revenue – points 360,000

Sale 360,000
Points redeemed = 4,000+4,100=8,100 11
Cumulative revenue = 8,100/9T*900T = 810,000
To be recorded in 2021 = 810,000 – 450,000 = 360,000

2022 Unearned revenue – points 90,000

Sale 90,000
Points redeemed = 4,000+4,100+900=9,000
Cumulative revenue = 9T/9T*900T = 900,000
To be recorded in 2021 = 900,000 – 810,000 = 90,000
 WARRANTY LIABILITY

It is connected with selling products and the provision of free repair

service or replacement during a specified period. Such is recognized as
liability because the entity has present obligation and it is probable that
an outflow of economic benefits will be required from the entity to settle
12
the obligation and the amount can be reliably measured.

Two approaches in accounting for warranty:

1. Accrual approach
2. Expense as incurred approach
 ACCRUAL APPROACH

Has the soundest theoretical support because there is proper

matching of cost with revenue

To record estimated warranty

13
Warranty expense xx
Est. warranty liability xx

To record actual warranty cost incurred and paid

Est. warranty liability xx
Cash xx
 EXPENSE AS INCURRED APPROACH

Expense warranty cost only when actually incurred

To record actual warranty cost 14

Warranty expense xx
Cash xx
EXAMPLE

An appliance company sells 1,000 TV sets at 27,000 each for cash.

Each set is under a warranty for one year. The entity has known from
past experience that warranty cost will probably average 1,500 per unit 15
and that only 60% of the units sold will return for repair. The company
incurs cost of repair of 540,000.
ENTRIES (ACCRUAL APPROACH)

Cash 27,000,00
Sales 27,000,000

Warranty expense (1T*60%*1,500) 900,000 16

Estimated warranty liab. 900,000

Estimated warranty liab. 540,000

Cash 540,000
ENTRIES (EXPENSE AS INCURRED APPROACH)

Cash 27,000,00
Sales 27,000,000 17

Estimated warranty liab. 540,000

Cash 540,000