02 Module 2 Premium Liabilities

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COLLEGE OF COMMERCE

BACHELOR OF SCIENCE IN ACCOUNTANCY

MODULE 2 PACKET
AE16 – INTERMEDIATE ACCOUNTING 2
MODULE 2 PREMIUM LIABILITIES:

Welcome to Module 2
In this module, we will discuss the conceptual framework in accounting that specifically discusses
premium liabilities. We will review the recognition, measurement and presentation of premium liabilities.
During the discussion, you will provide your appreciation of the different theoretical concepts that are
related to premium liabilities as well as the accounting treatment of transactions related to premium
liabilities. At the end of this module, you will be required to respond to questions that are designed to test
your understanding of the concepts and their application in the recognition, measurement and
presentation to the financial statements of premium liabilities.

LEARNING OUTCOMES:

By the end of this module, the students will be able to:

1. Identify transactions that will be qualify and be treated as premium liabilities.


2. Distinguish premium liabilities from other types of liabilities
3. Understand the recognition, measurement and presentation of premium liabilities in the financial
statements.
4. Discuss the application of the concepts and accounting treatment for premium liabilities through
scenario build up and problem solving e.g. loyalty programs.
ASSESSMENT PLAN:
1. Graded recitation through interactive participation in a question and answer format during discussion
2. Problem solving games (points awarded to the first 5 students who can submit the correct answer
and/or solution)
3. Individual Submission and discussion of homework or learning tasks through research online
4. Summative examinations in various evaluation/test formats

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LEARNING PLAN/SCHEDULE OF ACTIVITIES

ACTIVITY DESCRIPTION TIME TO


COMPLETE
Lecture Discussion Definition and classification of premium 1 hour
liabilities
Lecture Discussion Measurement of premium Liabilities 1 hour
Lecture Discussion Presentation of premium Liabilities 30 minutes
Lecture Discussion What is a loyalty program? 1 hour
Problem Solving Illustrative cases on recognition, classification, 1 hour
measurement and presentation of liabilities
Review Quick Reviews and Summarizations 30 minutes
Quiz Summative Quizzes for Module 3 1 hour

PRINTED REFERENCES

1. Valix, C. T., Peralta, J. F. & Valix, C. A. M. (2019). Conceptual framework and accounting
standards. 2019 edition. Manila : GIC Enterprises & Co., Inc. FIL 657.0218 V173c 2019
2. Valix, C. T., Peralta, J. F. & Valix, C. A. M. (2019). Intermediate accounting : volume one.
2019 revised edition. Manila : GIC Enterprises & Co., Inc. FIL 657.044 V173c 2019 v. 1
3. Valix, C. T., Peralta, J. F. & Valix, C. A. M. (2019). Intermediate accounting : volume two.
2019 revised edition. Manila : GIC Enterprises & Co., Inc. FIL 657.044 V173c 2019 v. 2
4. Valix, C. T., Peralta, J. F. & Valix, C. A. M. (2019). Intermediate accounting : volume three.
2019 revised edition. Manila : GIC Enterprises & Co., Inc. FIL 657.044 V173c 2019 v. 3
5. Cabrera, M. E. B. & Cabrera, G. A. B. (2019). Financial accounting and reporting
fundamentals. 2019-2020 edition. FIL 657.48 C117f 2019
6. Millan, Zeus Vernon B. Intermediate Financial Accounting II. Baguio City: Bandolin
Enterprise 2016

Web and Other Learning Resources


1. https://www.coursera.org/course/whartonaccounting
2. www.accountingverse.com/accounting-basics/fundamental-accounting-concepts.html
3. www.futureaccountant.com/accounting-process/
4. www.accountingcoach.com/accounting-basics/explanation
5. www.accounting-basics-for-students.com/basic-accounting-concepts.html
6. http://www.swlearning.com/accounting/murray/ppt/02.PPT
7. gpvec.unl.edu/bcpms/files/Financial/accounting2.ppt
8. http://www.picpa.com.ph/frsc.html?article=Philippine%20Financial%20Reporting
%20Standards&page=FRSC&main_menu=PFRSs

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COUSE CONTENT DISCUSSION

What are premiums?


 Premiums are articles of value such as toys, dishes, silverware and other goods
given to customers as result of past sales or sales promotion activities.
 A marketing sales strategy to increase sales of products, entities offer premiums to
customers in return for product labels, box tops, wrappers and coupons.
 Accordingly, WHEN THE MERCHANDISE IS SOLD, an accounting liability for future
distribution of the premium arises and should be given accounting recognition.
 Accounting procedures:
 When premiums (items to be given as prize) are purchased:
Premiums xx
Cash xx
 When the 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 each 3,000,000
 Soup bowls purchased, 2,000 units @ P50 each 100,000
 Wrappers redeemed 4,000

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 Accounting entries
1. To record the sales
Cash 3,000,000
Sales 3,000,000
2. To record the purchase of the premiums
Premiums – soup bowls 100,000
Cash 100,000
3. To record the redemption of 4,000 wrappers
Cash (800* x P10 redemption price) 8,000
Premium Expense (800 x P40**) 32,000
Premiums – soup bowls 40,000
*4,000 wrappers / 5 wrappers = 800 bowls to be distributed
**P50 cost/bowl less P10 - redemption price = P40/bowl

4. To record the liability at the end of the 1st Year


Premium Expense 16,000
Estimated Premium Liability 16,000
Wrappers to be redeemed (60% x 10,000 wrappers) 6,000
Less: Wrappers redeemed 4,000
Balance 2,000
Divide by No. of wrappers to redeem 5
Premiums to be distributed 400
Multiply by cost per bowl 40
Estimated Liability 16,000

5. At the end of the year, the accounts related to the premium plan are
classified and presented in the financial statements as follows:
Balance Sheet
Current Asset
Premiums – Soup Bowls 60,000

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Current Liability
Estimated Premium Liability 16,000

Income Statement
Distribution (Selling) Cost
Premium Expense 48,000

What are CASH REBATE PROGRAMS?


 It is another kind of premium program that promotes sales where a cash refund is
given to the customer upon submission of certain documents as proof of
purchase.
 Cash register receipts, bar codes, rebate coupons and other proof of purchase
often can be mailed to the manufacturer for cash rebate.
 Accounting Recognition Of Cash Rebates
 Estimated amount of 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 indicates 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
 Accounting entries
1. To recognize the cash rebate program
Rebate Expense 800,000
Estimated Rebate Liability 800,000
Rebate coupons issued 4,000 (TV sets sold)
Expected to be redeemed 40%(redemption experience)

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Coupon rebates to be redeemed 1,600


Cash rebate per coupon 500 (Cash rebate per TV set sold)
Estimated rebate liability 800,000

2. To record payments to customers


Estimated Rebate Liability 450,000
Cash 450,000

What is the accounting treatment for Cash Discounts?


 Similarly with premium offer and cash rebates, an expense and an estimated
liability for the expected cash discount shall 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.
 Accounting entries
1. To recognize the cash discount coupon offer
Cash Discount Coupon Expense 1,650,000
Estimated Discount Coupon Liability 1,650,000

Discount Coupons Issued at Face Amount 5,000,000


Estimated Redemption Based on Experience 30%
Face amount of coupons to be redeemed 1,500,000
Multiply by (100% redemption + 10% handling) 110%
Total coupon liability 1,650,000

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2. To record payments to retailers (given in the problem)


Estimated Coupon Liability 1,100,000
Cash 1,100,000

 The balance of the Estimated Coupon Liability at the end of the year will be
P550,000.

What is CUSTOMER LOYALTY PROGRAM (Credit Points Award System)?


 Designed to reward customers for past purchases by providing them with
incentives to make further purchases.
 Supports marketing strategy of building brand loyalty, retain valuable customers
and increase sales volume.
 How does CUSTOMER LOYALTY PROGRAM work?
 When a customer buys goods or services, AWARD CREDITS or “POINTS” are
given.
 Customer can redeem the “points” by granting the customer free or discounted
goods or services.
 Customers may be required to accumulate a specified number of award credits
or points before redemption.
 MEASUREMENT OF AWARD CREDITS OR POINTS
 Accounted for as a “SEPARATE COMPONENT OF THE INITIAL SALE
TRANSACTION.”
 Accounted as “FUTURE DELIVERY OF GOODS OR SERVICES.”
 IFRS 15, Par 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.
 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.

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 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 to the total number expected to be
redeemed.
 The estimated redemption rate is assessed each period.
 Changes in the total number expected to be redeemed do not affect the total
consideration for the award credits.
 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.
 The calculation of the revenue to be recognized in any one period is made on a
“cumulative bases” in order to reflect the changes in estimate.

 ILLUSTRATION 1
 A grocery retailer operates a customer loyalty program.
 The grocery 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 2020 amounted to P9,000,000 based on stand-alone selling
price.
 During 2020, the customers earned 10,000 points.
 Management expects that 80% or 8,000 of these points will be redeemed.
 The stand-alone selling price of each loyalty point is estimated at P100.

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 On December 31, 2020, 4,000 points have been redeemed in exchange for
groceries.
 In 2021, the 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.
 Computations
 Allocation of transaction price
Product sales 9,000,000
Points-stand-alone selling price (10,000 x 100) 1,000,000
Total 10,000,000

 Allocation of Sales
Product sales (9,000,000/10,000,000 x 9,000,000) 8,100,000
Points (1,000,000/10,000,000 x 9,000,000) 900,000
Total Transaction Price 9,000,000

 Accounting Entries
1. Initial sale in 2020
Cash 9,000,000
Sales 8,100,000
Unearned Revenue – Points 900,000

2. Redemption of 4,000 points in 2020


Unearned Revenue - Points 450,000
Sales 450,000
Revenue to be recognized in 2020 (4,000 / 8,000 x 900,000)

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3. Redemption of 4,100 points in 2021


Unearned Revenue - Points 360,000
Sales 360,000

Points redeemed in 2020 4,000


Points redeemed in 2021 4,100
Total points redeemed to Dec 31, 2021 8,100
Cumulative revenue on Dec 31, 2021
(8,100 / 9,000 x 900,000) 810,000
Revenue recognized in 2020 (450,000)
Revenue recognized in 2021 360,000

4. Redemption of 900 points in 2022


Unearned Revenue - Points 90,000
Sales 90,000
Points redeemed in 2020 4,000
Points redeemed in 2021 4,100
Points redeemed in 2022 900
Total points redeemed to Dec 31, 2021 9,000
Cumulative revenue on Dec 31, 2022
(9,000 / 9,000 x 900,000) 900,000
Revenue recognized in 2021 (810,000)
Revenue recognized in 2022 90,000

 ILLUSTRATION 2 – 3rd Party Operates Loyalty Program


 A retailer of electrical goods participates in a customer loyalty program
operated by an airline.
 The retailer grants program members one air travel point for every P1,000
spent on electrical goods.

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 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 each point.
 Solution

Se lling Price Fraction Allocation

Product Sale s 4 ,500,000.00 0.90 4 ,050,000.00

Points (5,000 x 100) 500,000.00 0.10 4 50,000.00

5,000,000.00 4 ,500,000.00

Revenue from points 450,000


Payments for 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.
 Accounting Entries
1. To record initial sale
Cash 4,500,000
Sales 4,050,000
Revenue from points 450,000
2. To record payment to airline
Loyalty program expense 300,000

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Cash 300,000

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