Chapter 2 Questions 1. What is premium? Answer: Premiums are articles of value such as toys, dishes, silverwares, and other goods in some cases c ash payments, given to customers as result o f past sales or sales promotion activities. In order to stimulate the sale of their products, entities offer premiums to customer in return 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. The accounting procedures for the ac quisition of premiums and recognition of premium liability are as follows: 1. When the premiums are purchased: Premiums
xxx
Cash
xxx
2. When the premiums are distributed to the customers: Premium expense
xxx
Premiums
xxx
3. At the end of the year, if the premium are still outstanding: Premium expense
xxx
Estimated premium liability
xxx
2. What is a customer loyalty program? Answer: Many entities use a customer loyalty program to build brand loyalty, retain their valuable customers and of course, increase sales volume. The customer loyalty program is generally designed to reward customers for past purchases and provide them with incentives to make furt her purchases.
If a customer buys goods or ser vices, the entity grants the customer award credits often described as "points". The entity can redeem the "points" by distributing to the customer free or discounted goods or services. A customer loyalty program operates in a variety of ways. Customers may be required to accumulate a specified minimum number of award credits or "points" before they can be redeemed. Award credits may be linked to individual purchases or group of purchases or to a continued custom over a specified period. The entity may operate a customer loyalty program itself or participate in a program operated by a third party. The awards offered may include goods or services supplied by the entity or rights to claim goods or services from a third party.
3. Explain the measurement of award credits or “points” granted in a customer loyalty program Answer: Under IFRIC 13, an entity shall account for the award credits as a "separately component of the initial sale transaction". In other words, granting of reward credits is effectively accounted for as a "future delivery of goods and services". Accordingly, the fair value of the consideration rece ived with respect to the initial sale shall be allocated between the award credits and the sale. The consideration allocated to the award credits is measured at fair value, meaning, the amount for which the award credits could be sold separately. The subsequent recognition of the amount allocated to the aw ard credits as revenue depends on the following: a. The entity supplies the award itself b. A third party supplies the awards 4. Explain the recognition of award credits if the entity supplies the awards itself Answer: If the entity supplies the award itself, t he 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 umber expected to be redeemed do not affect the total consideration for the award credits. Instead, the changes in the total number of awards credits expected to be redeemed shall be reflected in the amount of revenue recognized in the current and future periods. In other words, the calculation of the revenue to be recognized in any one period is made on a "cumulative basis" in order to reflect t he changes in estimate. 5. Explain the recognition of award credits if a third party supplies the awards Answer: if a third party supplies the awards, t he entity shall assesses whether it is collecting the consideration allocated to the award credits o n its own account as principal in the t ransaction, or on behalf of the third party as agent of the third party. Whether as principal or agent, the revenue for award credit is recognized at the point of initial sale. The reason is that at this point, the entity has already fulfilled its obligation to the customer by granting t he award credits and the third party is obliged to supply the awards and of course entitled to receive consideration for doing so. If the entity is collecting the consideration as principal in the transaction, the amount of revenue is equal to the gross consideration allocated to t he award credits. If the entity is collecting the consideration as agent of the third party, the amount of revenue is equal to the net amount retained on its account. This net amount is the difference between the consideration allocated to the award credits and the amount payable to the third party for supplying the awards. 6. Explain a warranty liability Answer: Entity policy like warranty services 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. According at t he point of sale, a liability is incurred. 7. Explain the two approaches of accounting for warranty cost Answer: 1.
Accrual approach It has the soundest theoretical support because it properly matches cost with revenue. At the
time of sale a liability for warranty cost ar ises and therefore should be given accounting recognition. Following this approach, the estimated warranty cost is recorded as follows: Warranty Expense
xxx
Estimated warranty liability
xxx
When actual warranty cost is subsequently incurred and paid, the entry is: Estimated warranty liability
xxx
Cash
xxx
At the certain date, the estimate is reviewed to determine its reasonableness and accuracy. The actual warranty cost is analyzed to validate the or iginal estimate. Any difference between estimate and actual cost is a change in estimate and therefore treated currently or prospectively, if necessary. Thus, if the ac tual cost exceeds the estimate, the difference is charged to warranty ex pense as follows: Warranty expense
xxx
Estimated warranty liability
xxx
The subsequent payment of the warranty cost is then charged to the estimated liability account. If actual cost is less than the estimate, the difference is an adjustment to warranty expense as follows: Estimated warranty liability
xxx
Warranty expense 2.
xxx
Expense as incurred approach It is the approach of expensing the warranty cost only when actually incurred. This approach is popular in 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.
8. Explain the sale of an extended warranty Answer: A warranty is sometimes sold separately from the product sold. When products are sold, the customers are entitled to the usual manufacturer’s warranty during a period. However, the seller may offer an “extended warranty” on the product but with additional cost.
In such a case, 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. However, if costs are expected to be incurred in performing services under the extended warranty contract, revenue is recognized in proportion to the costs to be incurred annually. 9. Explain payroll taxes Answer: Under our law, the entity as an employer is required to withhold from the salaries if each employee the following: a) Income tax payable by the employee b) Employee’s contribution to the SSS c)
Employees contribution for PhilHealth
d) Employees contribution to the Pag-ibig Fund Other deductions may be made by the em ployer from the salaries of the employees for union dues and group insurance as required by the c ontract. Such amount withheld from the salaries of the employees shall be recognized as current liability until remitted by the entity to the appropriate government authority. In addition to the amounts withheld from the salaries of t he employees, the entity is required by law to make a contribution for SSS, PhilHealth and Pag-ibig fund represe nting its share in the benefits of the employees. 10. Explain briefly value added taxes Answer: Under the National Internal Revenue Code, an e ntity is required to collect value added tax from customers on sale of tangible personal property and ce rtain services. Such value added taxes collected shall be remitted monthly to the BIR. 11. Explain gift certificates payable Answer: Many megamalls, department stores and supermarkets sell gift c ertificated which are redeemable in merchandise. The accounting procedures are:
1.
When the gift certificated are sold: Cash
xxx Gift certificates payable
xxx
*the latter account is current liability. 2.
When the gift certificates are redeemed: Gift certificates payable
xxx
Sales 3.
xxx
When the gift certificates expire: Gift certificates payable
xxx
Forfeited gift certificates
xxx
The forfeited gift certificates account is c lassified as other income. 12. What are the refundable deposits? Answer: Refundable deposits consist of cash or property received from customers but which are refundable after compliance with certain conditions. The best example of a refundable deposit is the customer deposit required for ret urnable containers like bottles, drums, tanks, or barrels. 13. What are the four variations in the computation of bonus? Answer: Large entities often compensate key officers and employees by way of bonus for superior income realized during the year. The main purpose of this scheme is to motivate officers and employees by directly relating their well being to the success of the entity. Four variations: a) As a certain percent of income before bonus and before tax b) As a certain percent of income after bonus but before tax c)
As a certain percent of income after bonus and after tax
d) As a certain percent of income after tax but before bonus
14. What is deferred revenue? Answer: Deferred revenue or unearned revenue is income already received but not yet earned. Deferred revenue may be realizable within a year or in more than one year fr om the end of the reporting period. 15. Is deferred revenue current or noncurrent? Answer: If the deferred revenue is realizable within one year, it is a current liability. If the deferred revenue is realizable in more than one year, it is classified as noncurrent liability.
