Learning Material # 2
Part II
PREMIUM AND WARRANTY
PREMIUM
Premiums are article 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
promotion activities.
In order to stimulate the sale of their products, entities offer premiums to customers
in return for product labels, box tops, wrappers and coupons.
Accordingly, when merchandise is sold, an accounting liability for the future
distribution of the premium arises and should be given accounting recognition.
The accounting procedures for the acquisition of premiums and recognition of the
premium liability are as follows:
1. When the premiums are purchased:
Premiums
Cash
xxx
xxx
2. When the 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
Illustration Problem
Jenny Corporation manufactures “LED Bulb” and sells it at P300 per unit. A soup
bowl is offered to customers on the return of 5 boxes plus a remittance of P10.
The bowls costs P50, and it is estimated that 60% of the boxes will be
redeemed.
The data for the first year concerning the premium plan are as follows:
Sales, 10,000 units @ P300
P3,000,000
Soup bowls purchased (2,000 units@P50/pc)
100,000
Wrappers redeemed
4,000
The entries to record the transactions:
1. Cash
Sales
To record the sales
#
P3,000,000
P3,000,000
2. Premiums-soup bowls
100,000
Cash
100,000
To record the purchased of the premiums
#
3. Cash (800 x 10)
8,000
Premium expense(800 x 40)
32,000
Premiums-soup bowls (800 x 50)
40,000
To record the redemption of 4,000 wrappers
#
4. Premium expense
16,000
Estimated premium liability
16,000
To record the liability for the premiums at the end of the 1st year.
#
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)
Estimated liability (P400 x 40)
400
P16,000
Financial statement presentation:
Current assets:
Premiums – soup bowls
P60,000
Current liability
Estimated premium liability
16,000
Distribution cost:
Premium expense
48,000
:
WARRANTY
Warranty or guarantee is to provide free repair service or replacement during a
specified period if the products are defective.
Home appliances like television sets, sound systems, refrigerators and cellphones,
other personal gadgets and the like are often sold under warranty . Such policy will give
a liability on the part of the entity at the point of sale.
There are two methods followed in accounting for the warranty cost, namely “accrual
approach” and “expense as incurred approach”.
Accrual Approach
The accrual approach has the soundest theoretical support because it properly
matches cost with revenue. As stated earlier, at the time of sale a liability for warranty
cost arises and therefore should be given accounting recognition. Under this approach,
the estimated warranty cost is recorded as follows:
Warranty expense
Estimated warranty liability
xxx
xxx
When actual warranty cost is subsequently incurred and paid the entry is:
Estimated warranty liability
Cash
xxx
xxx
At a certain date, the estimate is reviewed to determine its reasonableness and
accurate. 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. Thus, if the actual cost exceeds the
estimate, the difference is charged to warranty expense as follows:
Warranty expense
Estimated warranty liability
xxx
xxx
The subsequent payment of the warranty cost is then charged to the estimated liability
account.
If the actual cost is less than the estimate, the difference is an adjustment to warranty
expense as follows:
Estimated warranty liability
Warranty expense
xxx
xxx
Illustration Problem:
RCA Co. sells 1,000 units of Stereo radio sets at P9,000 each for cash. Each radio is
under warranty for one(1) year and the Co. 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 Co. incurs P180,000 for repairs during the year.
Journal entries;
1. Cash
Sales
To record the sales.
P9,000,000
P9,000,000
2. Warranty expense
300,000
Estimated warranty liability
To record the estimated liability on warranty
#
Estimated sets to be returned (60% x 1,000)
Multiply by estimated warranty cost per set
Estimated warranty cost
Estimated warranty liability
180,000
Cash
To record the payment of the actual cost.
#
Financial Statement Presentation:
300,000
600 sets
P 500
P300,000
3.
Current Liability:
Estimated warranty liability
Distribution cost:
Warranty expense
180,000
P120,000
300,000
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.
Expense as incurred approach
The approach is popular practice because it is the one recognized for income tax
purposes and frequently justified on the basis of expediency when warranty cost is not
very substantial or when the warranty period is relatively short.
On the above problem the actual warranty cost of P180,000 is simply recorded by
debiting warranty expense and crediting cash.
Illustrative Problem:
AIR Co. 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%
Sales and actual warranty repairs for two years are as follows:
2019
Sales
Actual warranty repairs
P5,000,000
140,000
2020
P6,000,000
300,000
Journal Entries
2019
1. Cash
P 5,000,000
Sales
P5,000,000
To record the sales
#
2. Warranty expense
700,000
Estimated warranty liability
700,000
(14% x P5,000,000)
To record the warranty expense
#
Note: that the total warranty expense each year is 14% to be incurred over a
2-year warranty period.
3. Estimated warranty liability
Cash
To record the actual warranty repairs.
#
140,000
140,000
2020
1. Cash
P6,000,000
Sales
P6,000,000
To record the sales
#
2. Warranty expense
840,000
Estimated warranty liability
840,000
To record the warranty expense
#
3. Estimated warranty liability
300,000
Cash
300,000
To record actual warranty expense
#
At this point o December 31, 2020, the estimated warranty liability is
P1,100,000 determined as follows:
Warranty expense
2019
2020
Actual warranty repairs
2019
2020
Estimated warranty liability –Dec.’20
--------0--------
P700,000
840,000
P140,000
300,000
P1,540,000
440,000
P1,100,000