INTERMEDIATE ACCOUNTING 2 1 st Semester, AY 2022-2023

Learning Material 2
PREMIUM LIABILITY

A. DISCUSSION OF ACCOUNTING PRINCIPLES

1. Premiums
a. To stimulate the sale of products, entities offer premiums to customers in return for product labels,
box tops, wrappers and coupons.
b. When the merchandise is sold, an accounting liability for the future distribution of the premium
arises and should be given accounting recognition.
c. The accounting procedures for the acquisition of premiums and recognition of the premium liability
are as follows:

1. When the premiums are purchased:

Premiums xx
Cash xx

2. When the premiums are distributed to customers:

Premium expense xx
Premiums xx

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

Premium expense xx
Estimated premium liability xx

Premiums are articles of value such as toys, dishes, silverware and other goods
given goods given to customers as result of past sales or sales promotion activities.

2. Cash Rebate Program

a. The purpose of a cash rebate program is to stimulate sales. This is another way of offering
premium.
b. The estimated amount of the cash rebate should be recognized both as an expense and an
estimated liability in the period of sale.

Cash register receipts, bar codes, rebate coupons and other proof of purchase often
can be mailed to the manufacturer for cash rebate.

3. Cash discount coupon

a. The purpose of a cash rebate program is also to stimulate sales. This is another variation of the
premium offer.
b. Similar to the 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.

4. Customer loyalty program

a. Entities use a customer loyalty program to build brand loyaty, retain their valuable customers and
increase sales volume.
b. 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
called “points”. These points are redeemed by the entity by distributing to the customer
free or discounted goods or services.
A customer loyalty program operates in a number of ways.

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B. APPLICATION EXERCISES

You are provided with exercises and the corresponding solutions. The objective is to demonstrate the
application of the accounting principles discussed for premium liability.

Exercise 1

Bing Company manufacturers a product that is packaged and sold. A plate is offered to customers sending
in three wrappers accompanied by a remittance of P10. Data with respect to the premium offer are
summarized below.
2021 2022
Sales 3,600,000 4,200,000
Purchase of premium, P50 per plate 390,000 580,000
Number of plate distributed as premiums 5,000 9,000
Estimated number of plates to be distributed in
subsequent period 2,000 3,000
Distribution cost P20 per plate 2,000 3,000

Required:
Prepare journal entries that would be made in 2021 and 2022 to record sales, premium purchases and
redemptions, and year-end adjustments.

Solution to Exercise 1

Journal entries for 2021:

1. Cash 3,600,000
Sales 3,600,000
To record sales.

2. Premiums 390,000
Cash 3,900,000
To record premium purchases.

3. Cash (5,000 x P10) 50,000

Premium expense (5,000 x P40) 200,000
Premiums (5,000 x P50) 250,000
To record redemptions.

4. Premium expense (2,000 x P20) 100,000

Cash 100,000
To record distribution expense.

5. Premium expense (2,000 x P60) 120,000

Estimated premium liability 120,000
To record year-end adjustments.
(P60 = P50 cost per plate + P10 remittance)

Journal entries for 2022:

1. Estimated premium liability 120,000

Premium expense 120,000
Reversing entry.

Cash 4,200,000
Sales 4,200,000
To record sales.

2. Premiums 580,000
Cash 580,000
To record premium purchases.

3. Cash (9,000 x P10) 90,000

Premium expense (9,000 x P40) 360,000
Premiums (9,000 x P50) 450,000
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 To record redemptions.

4. Premium expense (9,000 x P20) 180,000

Cash 180,000
To record distribution expense.

5. Premium expense (3,000 x P60) 180,000

Estimated premium liability 180,000
To record year-end adjustments.

Exercise 2

An entity offered P750 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 indicates that 40% of the coupons will be redeemed.

During the current year, the entity sold 8,000 TV sets and total payments to customers amounted to
P900,000.

Required:
Prepare journal entries to recognize the cash rebate program and to record the payments to customers.

Solution to Exercise 2

1. To recognize the cash rebate program:

Rebate expense 800,000

Estimated rebate liability 800,000

Rebate coupons issued 8,000

Expected to be redeemed 40%
Coupon rebates to be redeemed 3,200
x Cash rebate per coupon P750
Estimated rebate liability 2,400,000

2. To record the payments to customers:

Estimated rebate liability 900,000

Cash 900,000

Exercise 3

During the current year, an entity inserted in each package sold a coupon offering P600 of 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 coupon 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 P10,000,000 and total payments to
retailers amounted to 2,200,000.

Required:
Prepare journal entries to recognize the cash discount coupon and to record the payment to retailers.

Solution to Exercise 3

1. To recognize the cash discount coupon offer:

Cash discount coupon expense 3,300,000

Estimated coupon liability 3,300,000

Face amount of coupons to be redeemed (10,000,000 x 30%) 3,000,000

Multiply by (100% face plus 10% handling) 110%

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 Total coupon liability 3,300,000

2. To record payments to retailers:

Estimated coupon liability 2,200,000

Cash 2,200,000

Exercise 4

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. The points have no expiry date.

The sales during 2021 amounted to P18,000,000 based on stand-alone selling price. During 2021, the
customers earned 20,000 points. But management expects that 80% or 16,000 of these points will be
redeemed.
The stand-alone selling price of each loyalty point is estimated at P200.

On December 31, 2021, 8,000 points have been redeemed in exchange for groceries. In 2022, the
management revised expectations and now expects that 90% or 18,000 points will be redeemed
altogether. During 2022, the entity redeemed 8,200 points. In 2022, a further 1,800 points are redeemed.

Management continues to expect that only 18,000 points will ever be redeemed, meaning, no more points
will be redeemed after 2022.

Required: Prepare related journal entries for 2021 and 2022.

Solution to Exercise 4

1. To record initial sales in 2021:

Cash 19,800,000
Sales 16,200,000
Unearned revenue - points 3,600,000

Allocation of transaction price

Product sales 18,000,000

Points – stand-alone selling price (20,000 x P200) 4,000,000
Total 20,000,000

Product sales (18,000,000/20,000,000 x 18,000,000) 16,200,000

Points (4,000,000/20,000,000 x 18,000,000) 3,600,000
Total transaction price 19,800,000

2. To record redemption of 8,000 points in 2021:

Unearned revenue – points 1,800,000

Sales 1,800,000

Revenue to be recognized in 2020

(8,000/16,000 x P3,600,000) P1,800,000

3. To record redemption of 8,200 points in 2022:

Unearned revenue – points 1,440,000

Sales 1,440,000

Points redeemed in 2021 8,000

Points redeemed in 2022 8,200
Total points redeemed to December 31, 2022 16,200

Cumulative revenue on December 31, 2022 (16,200/18,000 x P3,600,000) 3,240,000

Revenue recognized in 2021 1,800,000
Revenue to be recognized in 2022 1,440,000

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4. To record redemption of 1,800 points in 2022

Unearned revenue – points 360,000 Sales

360,000
Points redeemed in 2020 8,000
Points redeemed in 2021 8,200
Points redeemed in 2022 1,800
Total points redeemed to December 31, 2022 18,000

Cumulative revenue – December 31, 2022 (18,000/18,000 x P3,600,000) 3,600,000

Cumulative revenue – December 31, 2021 3,240,000
Revenue to be recognized in 2022 360,000

Exercise 5

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 P5,000 spent on electrical goods.

Program members can redeem the points for travel with the airline subject to availability. The entity pays
the airline P300 for each point.

During the current year, the entity sold electrical goods for consideration totaling P8,500,000 based on
stand-alone selling price and granted 1,000 points with stand-alone selling price of P500 per point.

The entity has fulfilled its obligation by granting the points.

Required:
Journal entries for the initial sale and payment to airline.

Solution to Exercise 5

Selling Price Fraction Allocated

Product sales 8,500,000 85/90 8,027,778
Points (1,000 x P500) 500,000 5/90 472,222
9,000,000 8,500,000

Revenue from points 472,222

Payment to airline (1,000 x P300) (300,000)
Net revenue from points 172,222

1. To record the initial sale

Cash 8,500,000
Sales 8,027,778
Revenue from points 472,222

2. To record payment to airline

Loyalty program expense 300,000

Cash 300,000

C. EVALUATION EXERCISES
a. Theoretical Exercises

Choose the correct answer by writing the corresponding letter-answer and a convincing justification it is
indeed the correct answer. Briefly explain or provide justifiable reason/s via applicable appropriate
accounting principles discussed on premium liability.

1. The cost of customer premium offer should be charged to expense

a. When the related product is sold.
b. When the premium offer expires.
c. Over the life cycle of the product to which the premium relates.
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 d. When the premium is claimed.

2. The accounting concept that requires recognition of a liability for customer premium offer
is
a. Time period
b. Prudence
c. Historical cost
d. Matching principle

3. Accounting for cost of incentive program for frequent customer purchases involves
a. Recording an expense and a liability each period.
b. Recording a liability and a reduction of revenue each period.
c. Recording an expense and an asset reduction each period.
d. Recording an expense and revenue each period.

4. Accounting for cost of incentive program for customer purchases

a. Requires probability estimation.
b. Follows the matching principle.
c. Is a loss contingency situation.
d. All of these are correct.

5. Providing a monetary rebate program

a. Is accounted for similarity to a premium offer.
b. Creates an expense for the seller in the period of sale.
c. Creates a liability for the seller at the time of sale.
d. All of these are correct.

b. Practical Exercises

Solve the following problems with supporting computations presented in good form:

1. Vanessa Company manufactures a special laundry soap. A towel offered as a premium to customers
who send in two proof-of-purchase seals from the soap boxes and a remittance of P20. Distribution
cost is P5 per towel.

Data for the premium offer are:

2021 2022
Soap sales 2,500,000 3,125,000
Towel purchases, P100 per towel 175,000 200,000
Number of towels distributed as premium 1,000 1,800
Number of towels expected to be distributed in subsequent
period 600 800

Required:
1. Prepare journal entries for 2021 and 2022.
2. Statement classification of the account balances pertaining to the premium plan.

2. Angela Company operates a customer loyalty program. The entity grants loyalty points for goods
purchased. The loyalty points can be used by the customers in exchange for goods of the entity. The
points have no expiry date.

During 2021, the entity issued 50,000 award credits and expects that 80% of these award credits shall
be redeemed.

The stand-alone selling price of the award credits granted is reliably measured at P1,000,000. In
2021, the entity sold goods to customers for a total consideration of P7,000,000 based on stand-alone
selling price. The award credits redeemed and the total award credits expected to be redeemed each
year are as follows:
Redeemed Expected to be Redeemed
2021 15,000 80%
2022 7,950 85%
2023 2,550 85%
2024 15,000 90%

Required: Prepare journal entries from 2021 to 2024.

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3. In an effort to increase sales, Naruto Company inaugurated a sales promotional campaign on June 30.
The entity placed a coupon redeemable for a premium in each package of cereal sold. Each premium
cost P20 and five coupons must be presented by a customer to receive a premium.

The entity estimated that only 60% of the coupons issued will be redeemed.

For the six months ended December 31, 2020, the following information is available:
Packages of cereal sold 160,000
Premiums purchased 12,000
Coupons redeemed 40,000

a. Compute the amount that should be reported as premium expense.

b. Determine the estimated premium liability on December 31.

4. During 2021, Zaskie Company sold 500,000 boxes of cake mix under a new sales promotional
program. Each box contained one coupon, which entitled the customer to a baking pan upon the
remittance of P40. The entity paid P50 per pan and P5 for handling and shipping.

It estimated that 80% of the coupons will be redeemed, even though only 300,000 coupons had been
processed during the current year.

a. Determine the amount that should be reported as premium expense.

b. Ascertain the amount that should be reported as liability for unredeemed coupons at year-end.

5. Biboy Company offers customers a pottery cereal bowl if they send in three boxtops from its products
and P10. It estimated that 60% of the boxtops will be redeemed.

During the current year, the entity sold P675,000 boxes and customers redeemed 330,000 boxtops
receiving 110,000 bowls. The cost of each bowl is P25.

a. Determine the amount that should be reported as premium expense.

b. Ascertain the amount that should be reported as liability for outstanding premiums at year-end.

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