Question

On the back of its cereal boxes, Tiger Cereal Company offers a premium to its customers. The premium, a toy truck, may be claimed by sending in $1 plus 10 coupons; one coupon is included in each box of cereal sold. Tiger estimates, based on past experience, that 60% of the coupons will be redeemed. During 2016, Tiger purchased 240,000 toy trucks at $1.25 each for the premium promotion and sold 5,000,000 boxes of cereal, for cash, at $1.80 per box. In 2016, 2,200,000 coupons were redeemed.

Required:

1.	Prepare the journal entries related to the previous promotion (including sales) for 2016.
2.	Show how the items related to the premium plan would be reported on the December 31, 2016, balance sheet.
3.	Next Level What would be the effect on the financial statements if Tiger recorded premium expense as the coupons were redeemed?

Answer 1

1.

Date	General Journal	Debit	Credit
2016	Premium inventory	300000
	Cash (240000 x $1.25)		300000
	(To record premium inventory of toy trucks purchased)
	Cash (5000000 x $1.80)	9000000
	Sales revenue		9000000
	(To record sales of cereal boxes for cash)
Dec. 31, 2016	Premium expense	75000
	Premium liability [5000000 x 60% x 1/10 x ($1.25 - $1.00)]		75000
	(To record premium expense accrued on boxes sold)
Dec. 31, 2016	Cash (2200000 x 1/10 x $1)	220000
	Premium liability	55000
	Premium inventory (2200000 x 1/10 x $1.25)		275000
	(To record coupons redeemed)

2.

Tiger Cereal Company
Balance Sheet (Partial)
December 31, 2016
Current assets:
Premium inventory	25000
Current liabilities:
Premium liability	20000

3. According to the matching principle of accounting, expenses must be reported in the same accounting period in which the related sales are reported. Hence, the premium expense pertaining to the sales in 2016 are accrued in 2016 itself. If Tiger recorded the premium expense as coupons were redeemed, the matching principle would be violated. The effect of the same on the income statement would be that the expenses would be understated and thus, net income would be overstated by $75000 - $55000 = $20000. On the balance sheet, the current liabilities would be understated and equity would be overstated by $20000.