Premium Warranty And Liability

Premiums
Premiums are articles of value such as toys, dishes, silverware
and other goods, and in some cases cash payments given to
customers as result of past sales or sales promotions activities.
In order to stimulate the sale of their products, entities offer
premiums to customers in returns for product labels, box tops,
wrappers and coupons.
Accordingly, when the merchandise is sold, an accounting liability
for the future distribution of the premium arises and should be
given accounting recognition.
 Accounting procedure for the acquisition
and recognition of premium liability
When premiums are purchased :
Premiums xx
Cash xx

When premiums are distributed to customers”

Premium Expense xx
Premiums xx

At the end of the year, if premiums are still outstanding:

Premium Expense xx
Estimated Premium Liability xx
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@ 3,000,000 Wearable tech and VR (2015)
Founded (2007)
Soup bowls purchased, 2,000 units at P50@ 100,000
Wrappers redeemed 4,000
Pornhub Select (013)

ENTRIES :
To record the sales :
Cash 3,000,000
Sales 3,000,000 Blocked in Russia (2014)

Boughtof
To record the purchase outthe
by premiums :
MindGeek (2013)
Premiums – soup bowls 100,000
Cash 100,000
To record the redemption of 4,000 wrappers :
Cash (800x10) 8,000
Premium Expense (800x40) 32,000
Premiums – soup bowls (800x50) 40,000
(4,000 wrappers / 5 = 800 bowls distributed)

To record the liability for the premiums at the end of the first year :
Premium Expense 16,000
Estimated premium liability 16,000

COMPUTATION :

Wrappers to be redeemed (60% x 10,000 wrappers) 6,000

Less : Wrappers redeemed 4,000
Balance 2,000
=====
Premiums to be distributed 400 =====
Estimated warranty liability (400 x 40) 16,000
======
Financial Statement Classification:
Current Asset :
Premiums – soup bowls 60,000
Current Liability :
Estimated premium liability 16,000
Distribution Cost :
Premium Expense 48,000
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 premium 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 of TV set. The customers must
present a rebate coupon enclosed in every package sold plus the official receipt. Past
experience indicate that 40% of the coupons will be redeemed. During the current year,
the entity sold 4,000 TV sets and total payments to customers amounted to P450,000.

To recognize the cash rebate program:

Rebate expense 8000,000
Estimated rebate liability 800,000

Rebate coupons issued 4,000

Expected to be redeemed 40%
Coupon rebates to be redeemed 1,600
Cash rebate per coupon 500
Estimated rebate liability 800,000
To record the payments to customers:
Estimated rebate liability 450,000
Cash 450,000
Cash discount coupon
Another variation of the premium offer is the cash discount coupon program.
The cash discount coupon program is a popular marketing toll 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 present to the
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 value of P5,000,000 and total payments
to retailers amounted to P1,100,000.
To recognize the cash discount coupon offer:
Cash discount coupon expense 1,650,000
Estimated coupon liability 1,650,000

Face amount to be redeemed

(30% x 5,000,000) 1,500,000
Face amount plus handling 110%
Total coupon liability 1,650,000

To record payments to retailers:

Estimated coupon liability 1,100,000
Cash 1,100,000
Customer loyalty program
Many entities use a customer loyalty program to build brand loyalty, retain their valuable
customers and increase sales volume. It is designed to reward customers for past
purchases and provide incentives to make further purchases.
AWARD CREDITS - points granted to customers who buys goods and services, which has
to be accumulated to a specified minimum number before it can be redeemed.
Measurement:
An entity should account for the award credits as a separate component of the initial sale
transaction. The granting of the award credits is effectively accounted for as a “future delivery of
goods or services”
The entity shall allocate the transaction price to each performance obligation identified in a contract
on a relative stand-alone selling price basis.. 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.
Stand-alone selling price is the price at which an entity would sell a promised good or service
separately to customer.
Recognition:

Deferred Revenue = initial recognition of the consideration allocated to the awards

credits.
Revenue = recognition of redeemed award credits.

The amount of revenue recognized shall be based on the number of award credits that
have been redeemed relative to the total number expected to be redeemed.

The estimated redemption is assessed each period. Changes in the total number
expected to be redeemed do not affect the total consideration for the award credits.
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. The calculation of
the revenue to be recognized in any one period is made on 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 on groceries.
Program members can redeem the points for further groceries since it has no expiry date.
The sales during 2016 amounted to P7,200,000 based on stand-alone selling price.
During 2016, the customers earned 10,000 points. But management expects that 80% or
8,000 or these points will be redeemed. The stand-alone selling price of each loyalty
point is estimated at P100. On December 31, 2016, 4,000 points have been redeemed in
exchange for groceries. In 2017, the management revised its expectations to 90% or
9,000 points will be redeemed altogether.
During 2017, the entity redeemed 4,100 points. In 2018, 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 2018.
Allocation of transaction price:
Product Sales 7,200,000
Points – stand-alone selling price (8,000x100) 800,000
Total 8,000,000

Product Sales (7,200,000/8,000,000x7,200,000) 6,480,000

Points(800,000/8,000,000x7,200,000) 720,000
Total Transaction price 7,200,000

JOURNAL ENTRIES :
Initial sale in 2016 is recorded as follows ;
Cash 7,200,000
Sales 6,480,000
Unearned revenue – points 720,000

The redemption of 4,000 points is record as :

Unearned revenue – points 360,000
Sales 360,000
In 2017, the redemption of 4,100 points is recorded as :
Unearned revenue-points 288,000
Sales 288,000
Points redeemed in 2016 4,000
Points redeemed in 2017 4,100
Total points redeemed to 12/31/2017 8,100

Cumulative revenue on Dec. 31, 2017

(8,100/9,000 x 720,000) 648,000
Revenue recognized in 2016 (360,000)
Revenue to be recognized in 2017 288,000

In 2018, the redemption of 900 points is recorded as:

Unearned revenue – points 72,000
Sales 72,000

Points redeemed in 2016 4000

Points redeemed in 2017 4100
Points redeemed in 2018 900
Total points redeemed to 12/31/2018 9,000

Cumulative Revenue – December 31, 2018

(9,000/9,000 x 720,000) 720,000
Cumulative Revenue – December 31, 2017 (648,000)
Revenue to be recognized in 2018 72,000
WARRANTY
Home appliances like television sets, stereo sets, radio 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 on the part of the entity
if the products sold prove to be defective in the future within the specified period of time.
Accordingly, at the point of sale, liability is incurred.

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 xx
Estimated Warranty Liability xx

When actual warranty cost is subsequently incurred and paid, the entry is:
Estimated Warranty Liability xx
Cash xx
Any difference between estimate and actual cost is a change in estimate and therefore
treated currently or prospectively, if necessary.
If the actual cost exceeds the estimate, the difference is charged to warranty expense as
follows :
Warranty Expense xx
Estimated warranty liability xx
If the actual cost is less than the estimate, the difference is an adjustment to warranty
expense as follows :
Estimated warranty liability xx
Warranty Expense xx
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 only 60% of the units sold will be returned for repair. The entity
incurs P180,000 for repairs during the year
JOURNAL ENTRIES
To record the sales :
Cash 9,000,000
Sales 9,000,000

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 1000) 600 sets

Multiply by estimated warranty cost per set 500
Estimated warranty cost 300,000

To record the payment of the actual cost :

Estimated warranty liability 180,000
Cash 180,000

* The statement of financial position at the end of the year would report estimated warranty liability of P120,000 as a current liability
 Expense incurred approach
The approach of expensing warranty cost only when actually incurred. This approach is justified on
the basis of expedency when warranty cost is not very substantial or when the warranty period is
relatively short.
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%

2016 2017
Sales 5,000,000 6,000,000
Actual warranty repairs 140,000 300,000
Journal Entries:
2016
To record the sales :
Cash 5,000,000
Sales 5,000,000

To record the warranty expense

Warranty expense 700,000
Estimated warranty liability 700,000
(14% x 5,000,000)
Note that the total warranty expense each year is 14% to be incurred over a 2-year warranty period.

To record the actual warranty repairs:

Estimated warranty liability 140,000
Cash 140,000

2017
To record the sales :
Cash 6,000,000
Sales 6,000,000

To record the warranty expense :

Warranty expense 840,000
Estimated warranty liability 840,000
(14% x 6,000,000)

To record the actual warranty repairs :

Estimated warranty liability 300,000
Cash 300,000
At this point, on December 31, 2017, the estimated warranty liability is P1,100,000, determined as
follows :

Warranty Expense :
2016 700,000
2017 840,000 1,540,000
Actual Warranty Expense :
2016 140,000
2017 300,000 440,000
Estimated Warranty Liability, 12/31/17 1,100,000

Testing the accuracy of warranty liability

On December 31, 2017, the estimated warranty liability account may be analyzed based on 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 year under a 2-year warranty of the sales made on January 1, 2016 will be within January 1, 2016 to December
31, 2016 and the second contract year will be within January 1, 2017 to December 31, 2017. The first contract year under a 2-year warranty of the sales made
on July 1, 2016 will be within July 1, 2016 to June 30, 2017 and the second contract year will be within July 1, 2017 to June 30, 2018.

Computations :
If sales and warranty repairs are made evenly during the year, the warranty expense for 2016-2017 and the estimated warranty liability on December
31, 2017 are determined as follows :

Warranty Expense Related to 2016 sales :

2016
First contract year of January 1, 2016 sales
(2,500,000 x 4%) 100,000
First contract year of July 1, 2016 sales
(2,500,000 x 4% x 6/12) 50,000

2017
First contract year of July 1, 2016 sales
(2,500,000 x 4% x 6/12) 50,000
Second contract year of July 1, 2016 sales
(2,500,000 x 10%) 250,000
Second contract year of July 1, 2016 sales
(2,500,000 x 10% x 6/12) 125,000

2018
Second year contract year of July 1, 2016 sales
(2,500,000 x 10% x 6/12) 125,000
Total Warranty Expense for 2016 700,000
Warranty Expense related to 2017 sales :
2017
First contract year of January 1, 2017 sales 120,000
(3,000,000 x 4%)
First contract year of July 1, 2017 sales
(3,000,000 x 4% x 6/12) 60,000

2018
First contract year of July 1, 2017 sales
(3,000,000 x 5% x 6/12) 60,000
Second contract year of January 1, 2017 sales
(3,000,000 x 10%) 300,000
Second contract year of July 1, 2017 sales
(3,000,000 x 10% x 6/12) 150,000

2019
Second contract year of July 1, 2017 sales
(3,000,000 x 10% x 6/12) 150,000
Total Warranty Expense for 2017 840,000
The warranty costs after December 31, 2017 represent the estimated warranty liability on December 31, 2017.
2016 sales under warranty after December 31, 2017
Second contract year of July 1, 2016 sales 125,000
2017 sales under warranty after December 31, 2017:
First contract year of July 1, 2017 sales 60,000
Second contract year of January 1, 2017 sales 300,000
Second contract year of July 1, 2017 sales 300,000

Estimated warranty liability – Dec. 31, 2017 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 2017 as follows :

Estimated warranty liability 315,000

Warranty Expense 315,000
SALE OF WARRANTY :
A warranty is sometimes sold separately from the product. When the 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.
The sale of the product with the usual warranty is recorded separately from the sale of the 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.

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 follows :
Cash 3,060,000
Sales 3,000,000
Unearned warranty revenue 60,000
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 follows :

Unearned warranty revenue 30,000

Warranty Revenue (60,000,2years) 30,000