Question

Edwards Co. includes one coupon in each bag of dog food it sells. In return for 4 coupons, customers receive a dog toy that the company purchases for £1.20 each. Edwards's experience indicates that 60 percent of the coupons will be redeemed. During 2018, 100,000 bags of dog food were sold, 12,000 toys were purchased, and 50,000 coupons were redeemed. During 2019, 120,000 bags of dog food were sold, 16,000 toys were purchased, and 60,000 coupons were redeemed.

1. Calculate the premium liability at the end of 2018. Show your workings.
2. Calculate the actual number of dog toy given to customers in 2019. Show your workings.
3. Why do companies want to offer premium to customers? Explain the accounting principle and treatment for consideration payable.
4. A clerical staff has tried to calculate the premium expense to be shown in the income statement for 2018. He said that the figure of actual number of coupons redeemed in year 2018 is required in order to calculate the premium expense for 2018. Do you agree with him? Why? Also, he argued that the figure of sales volume of dog food in 2018 is not required to calculate the premium expense for 2018. Do you agree with him? Why? (No need to show any calculation)
5. The clerical staff also said that the sales volume of dog food in 2018 is not relevant for him to calculate the premium liability at 31 Dec 2018. Do you agree with him? Explain the reasons. (No need to show any calculation)
6. If cash with an amount of less than £1.2 is received from customer for each dog toy given, explain how this would affect the premium expense in 2018? (No need to show any calculation)
7. If cash with an amount of less than £1.2 is received from customer for each dog toy given, explain how this would affect the premium liability at the end of 2018? (No need to show any calculation)
8. The clerical staff argued that if the sales volume of dog food in 2018 is recorded wrongly, it would not have any effect on the accurateness of the premium liability at the end of 2019, because premium liability at the end of 2019 is related to sales volume of dog food in 2019, but not related to the sales volume of dog food in 2018. Do you agree with him? Explain the reasons. (No need to show any calculation)

Answer 1

Answer-a:

In 2018:

Premium = (Number of bags sold / Number of coupons exchanged for one toy) × Estimates of redeemable coupons × Cost of each toy

=(100,000 bags / 4 coupons) × 60% × $1.20 = $18,000

Premium liability = Premium − [(Number of coupons redeemed / Number of coupons required to exchange one toy) × Cost of each toy)]

=$18,000−[(40,000 coupons / 4 coupons) × $1.20)] = $6,000

Answer-b:

Actual no. of toys given to customer in 2019 =

= No. of coupons redeemed / Number of coupons required to exchange one toy

= 60,000 coupons / 4 coupons

= 15,000 toys

Answer-c:

Premiums and coupons are the offers provided to the customers with the objective to attract them towards the product.

Companies want to offer premium to customers to build customer base, introduce new customers to stores, to get rid of unwanted inventory to make room in the warehouse or store for newer product, encouraging customers to try a new brand that is more profitable to you or getting customers to come back to your store.

The consideration payable guidance states that the consideration payable should be recognized as a reduction of revenue at the date the offer is communicated. The entity should reverse the revenue when the consideration payable to a customer is promised. The constraining variable consideration states that the reversals of revenue should happen as little as possible and as early as possible.

Answer-d:

No, actual number of coupons redeemed in year 2018 is not required in order to calculate the premium expense for 2018 because as per GAAP, premium expense is calculated on a probable basis.

A company estimates that customers will take advantage of a premium offer and receive free products depending on the premiums redeemed. Only on this basis company calculate premium expense.

Sales volume of dog food in 2018 is required to calculate the premium expense for 2018 because it is the actual sales volume which help in estimating the probable redemption of coupons. Hence, sales volume can not be ignored for calculation of premium expense.