02 Handout 1 PDF - Accounts Payable, Premiums, Warranty, Accrued Liability, And Deferred Revenue

BM2403 ACCOUNTS PAYABLE, PREMIUMS, WARRANTY, ACCRUED LIABILITY, AND DEFERRED REVENUE ACCOUNTS PAYABLE (Kieso, et al., 2016) Accounts payable, or trade payable, is the...

BM2403 ACCOUNTS PAYABLE, PREMIUMS, WARRANTY, ACCRUED LIABILITY, AND DEFERRED REVENUE ACCOUNTS PAYABLE (Kieso, et al., 2016) Accounts payable, or trade payable, is the amount an entity owes to purchase goods, raw materials, or services in the ordinary business. This obligation is evidenced by regular invoices rather than separate contracts per transaction. According to Kieso et al. (2016), most accounting systems are designed to record liabilities for purchases of goods when the goods are received. Sometimes, there is a delay in recording the goods and the related liability on the books, such as when waiting for an invoice. If the title has passed to the purchases before the goods are received, the transaction should be recorded when the title passes. Cash discounts (purchase discounts from the purchaser’s perspective) are terms or favors the seller gives to a buyer designed to encourage an early payment of the account owed. The following are examples of cash discount terms: 2/10, n/30 – 2% discount if paid within 10 days, net due in 30 days 1/10, n/30 – 1% discount if paid within 10 days, net due in 30 days 2/10, n/10 EOM – 2% discount if paid within 10 days, net due on the 10th day after the end of the month Methods in Accounting for Cash Discounts Gross Method - The entity would initially record the purchase account and accounts payable at the full invoice price. Purchase discounts are recorded only if the entity paid the amount owed within the discount period. Illustrative Example 1: On November 2, 2X19, Shayne Company purchased equipment from Allen Appliance Center with an invoice price of P350,000 and a credit term of 2/10, n/30. The journal entry to record this transaction on November 2, 2X19, is as follows: Purchases 350,000 Accounts payable 350,000 Assuming that Shayne Company paid the whole on November 11, 2X19. Then, the journal entry to record the payment is as follows: Accounts payable 350,000 Purchase discount 7,000 Cash 343,000 Net Method - The entity would initially record the purchase account and accounts payable at the net invoice price. Purchase discounts are deducted from the full invoice price to record the purchase transaction. Suppose the entity fails to pay within the discount period. In that case, a Purchase Discount Lost account should be debited and added to the full amount to be paid upon settlement of the obligation. 02 Handout 1 *Property of STI  [email protected] Page 1 of 11  BM2403 Using the same information given in Illustrative Example 1 with an exemption that the company uses the net method in recording its purchase transaction, the journal entry on November 2, 2X19 would be: Purchases 343,000 Accounts payable 343,000 Assuming that Shayne Company paid the whole on November 30, 2X19. Then, the journal entry to record the payment is as follows: Accounts payable 343,000 Purchase discount lost 7,000 Cash 350,000 PREMIUMS AND CUSTOMER LOYALTY PROGRAM (Kieso, et al., 2016) Premiums Many companies offer premiums or other benefits to customers in return for box tops, coupons, labels, wrappers, or other evidence of having purchased a particular product. The premiums may be such items as silverware, dishes, small appliances, toys, or cash values against future purchases (Kieso et al., 2016). The accounting issue for premiums is that while these promotions increase current sales revenue, the associated costs are often incurred in future periods. The matching concept requires companies to deduct the total estimated costs against the current period’s revenue, and the cost is charged to an expense account such as Premium or Promotion Expense. In addition, the obligations existing at the date of the statement of financial position must also be recognized and reported in a liability account, such as Estimated Liability for Premiums or Estimated Liability for Coupons Outstanding. Illustrative Example 2: In 2X19, Mallows Corporation offers customers a large, non-breakable mixing bowl in exchange for P10 and 10 box tops. The mixing bowl costs Mallows Corporation P50, and the company estimates that 60% of the box tops will be redeemed. Assuming the company purchased 20,000 mixing bowls at P50. The journal entry for the transaction is as follows: Premium - mixing bowls 1,000,000 Cash 1,000,000 Subsequently, Mallows sold 200,000 (in boxes) of its products for P1,000,000. In that sale, 100,000 box tops were presented to Mallows for redemption, receiving P10 with every 10 box tops. The journal entry to record the transaction is as follows: Sale of Products: Cash (or Accounts receivable) 1,000,000 Sales 1,000,000 Redemption of Premiums: Cash (10,000 x 10) 100,000 02 Handout 1 *Property of STI  [email protected] Page 2 of 11  BM2403 Premium expense (10,000 x 40) 400,000 Premiums - mixing bowls (10,000 x 50) 500,000 Liability for Premiums at year-end: Premium expense 80,000 Estimated premium liability 80,000 Solution: Box tops to be redeemed (60% x 200,000 boxes) 120,000 Less: Box tops redeemed 100,000 Balance 20,000 Premiums to be distributed (20,000/10) 2,000 Estimated liability (2,000 x P40) P80,000 Customer Loyalty Program Many entities use customer loyalty programs to establish brand faithfulness, increase sales volume, and retain valuable customers. This program usually gives customers “awards” or “corresponding points” for every purchase. Customers can use such points as part or full payment for future goods or services purchases. Under IFRS 15, Revenue from Contracts with Customers, the revenues from contracts with customers shall be recognized when the entity satisfies the performance obligation. The transaction price on the contract shall be apportioned to the performance obligations when the contract requires a series of performance obligations. The allocation shall be based on relative stand-alone selling prices of each distinct good or service promised in the contract (Robles & Empleo, 2016). Thus, when an entity provides customer loyalty awards on the principal goods or services sold, the consideration received or receivable by an entity for goods sold is apportioned between the products (Robles & Empleo, 2016). Illustrative Example 3 (Robles & Empleo, 2016): SM Corporation grants its customers one (1) reward point for each P200 sale. Each point is redeemable in the form of merchandise equivalent to P1. The points accumulated may be used by a customer as payment for merchandise in the future. During April of the current year, the company's total sales amounted to P24,000,000. Fair merchandise values and reward points are P23,880,000 and P120,000, respectively. The journal entry at the time of sale is as follows: Cash 24,000,000 Sales 23,880,000 Liability for customer loyalty awards 120,000 By the end of the first year, 45% of the points have been redeemed, and customers are expected to redeem only 90% of the points granted. SM recognizes revenue for points redeemed at P60,000 (45%/90% x P120,000). 02 Handout 1 *Property of STI  [email protected] Page 3 of 11  BM2403 The journal entry for the redemption is as follows: Liability for customer loyalty awards 60,000 Sales 60,000 ACCOUNTING FOR WARRANTY (Kieso, et al., 2016) A warranty (product guarantee) is a promise made by a seller to a buyer to correct problems experienced with a product’s quantity, quality, or performance. Manufacturers commonly use warranties to promote sales. These are the two (2) approaches followed in accounting for the warranty cost (Robles & Empleo, 2016): 1. Accrual Approach - It has the soundest theoretical support because it matches cost with revenue properly. 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 a certain date, the estimate is reviewed to determine its reasonableness and accuracy. The actual warranty cost is analyzed to validate the original estimate. Any difference between the estimate and actual cost is a change in accounting estimate and, therefore, treated currently and prospectively, if necessary. Thus, if the actual cost exceeds the estimate, the difference is charged to warranty expense as follows (Valix, Peralta, & Valix, 2023): Warranty expense XXX Estimated warranty liability XXX If the actual cost is less than the estimated, the difference is an adjustment to warranty expense as follows: Estimated warranty liability XXX Warranty expense XXX Illustrative Example 4 (Valix, Peralta, & Valix, 2023): An entity sells 1,000 units of television sets at P9,000 each for cash. Each set is under warranty for one (1) year, and the entity has estimated from experience that warranty cost will probably average P500 per unit and that only 60% of units sold will be returned for repair. The entity incurs P180,000 for repairs during the year. To record the sale, the entry is as follows: 9,000,000 Cash Sales 9,000,000 02 Handout 1 *Property of STI  [email protected] Page 4 of 11  BM2403 To set up the estimated liability on the warranty, the entry is: 300,000 Cash Sales 300,000 Solution: Estimated sets to be returned (60% x 1,000 sets) 600 Multiply by the estimated warranty cost per set 500 Estimated warranty cost 300,000 To record the payment of the actual cost, the entry is: Estimated warranty liability 180,000 Cash 180,000 2. The expense as incurred approach is the approach of expensing warranty cost only when incurred. This approach is popular in practice because it is recognized for income tax purposes and frequently justified based on expediency when warranty cost is not very substantial or the warranty period is relatively short (Valix, Peralta, & Valix, 2023). Illustrative Example 5 (Valix, Peralta, & Valix, 2023): An entity sells refrigerators that carry a two-year warranty against defects. The sales and warranty repairs are made evenly throughout the year. Based on past experience, the entity projects an estimated warranty cost as a percentage of sales as follows: First year of warranty 4% Second year of warranty 10% Sales and actual warranty for two (2) years are as follows: 2X15 2X16 Sales 5,000,000 6,000,000 Actual warranty repairs 140,000 300,000 2X15 2X16 To record the sale, the entry is as follows: To record the sale, the entry is as follows: Cash 5,000,000 Cash 6,000,000 Sales 5,000,000 Sales 6,000,000 To record warranty expense, the entry is: To record warranty expense, the entry is: Warranty expense 700,000 Warranty expense 840,000 Estimated warranty 700,000 Estimated liability 840,000 warranty liability (14% x 5,000,000) (14% x 6,000,000) To record the actual warranty repairs, the entry is: To record the actual warranty repairs, the entry is: Estimated warranty 140,000 Estimated warranty liability 300,000 liability Cash 140,000 Cash 300,000 02 Handout 1 *Property of STI  [email protected] Page 5 of 11  BM2403 At this point, on December 31, 2X16, the estimated warranty liability is P1,100,000 determined as follows: Warranty expense - P1,540,000 (P700,000 + P840,000) – Actual warranty repairs P440,000 (P140,000 + P300,000) PAYROLL TAXES (Valix, Peralta, & Valix, 2023) In the Philippine setting, companies withhold a certain amount from the salaries of each employee. This amount covers the following: Income tax payable by the employee; and Employee contributions to o Social Security System (SSS), o Home Development Mutual Fund (HDMF or Pag-IBIG fund) and o Philippine Health Insurance Corporation (PhilHealth). Those amounts withheld should be recognized as current liability until remitted to the appropriate government agency. Illustrative Example 6: Royal Company reported the payroll of its employees for September: The report shows the following: Gross payroll P500,000 Income taxes withheld (20,000) SSS contribution (4,000) Pag-IBIG contribution (2,000) PhilHealth contribution (1,000) Net payroll P473,000 The journal entry to record the gross payroll is as follows: Salaries 500,000 Withholding tax payable 20,000 SSS payable 4,000 Pag-IBIG payable 2,000 PhilHealth payable 1,000 Cash 473,000 GIFT CERTIFICATES PAYABLE (Valix, Peralta, & Valix, 2023) Many megamalls, department stores, and supermarkets sell gift certificates redeemable in merchandise. The accounting procedures for this type of activity are as follows. When gift certificates are sold: Cash XXX Gift certificates payable XXX When gift certificates are redeemed: Gift certificates payable XXX Sales XXX 02 Handout 1 *Property of STI  [email protected] Page 6 of 11  BM2403 When gift certificates are not redeemed: Gift certificates payable XXX Forfeited gifts certificates XXX Illustrative Example 7: Assume the following information for Glorietta Corporation for the year 2X16. Glorietta has a pricing policy allows 30% profit on the sales price. Unearned revenue from gift certificates outstanding, January 1, 2X16 P 500,000 Gift certificates sold during the year 1,800,000 Gift certificates issued relating to sales promotion during the year 200,000 Gift certificates redeemed during the year 1,800,000 Gift certificates relating to the entity’s promo that expired during the year 25,000 Additional outstanding gift certificates are expected to expire in 2X17 12,000 The following are the entries for the year 2X16 related to the previous information: Cash 1,800,000 Unearned revenue for gift certificates outstanding 1,800,000 Sold gift certificates Cash 200,000 Sales 200,000 Unearned revenue for gift certificates outstanding Unearned revenue for gift certificates outstanding 1,800,000 Sales 1,800,000 Redeemed gift certificates Unearned revenue for gift certificates outstanding 25,000 Gift from forfeited gift certificates 25,000 Redeemed gift certificates Breakage Revenue Under IFRS 15, the non-redemption of the gift certificates is referred to as “breakage.” The seller shall recognize revenue from breakage based on the value of certificates redeemed in proportion to the expected value of certificates to be redeemed. Illustrative Example 8: During the current year, an entity sold gift certificates worth P5,000,000 to customers in exchange for future delivery of its product. The gift certificates are nonrefundable, and the entity expects that 10% will not be redeemed. The entity redeemed gift certificates worth P1,800,000 during the current year. 02 Handout 1 *Property of STI  [email protected] Page 7 of 11  BM2403 Expected value of breakage (5,000,000 x 10%) P500,000 Expected value of certificates to be redeemed (5,000,000 x 90%) 4,500,000 Value of certificates redeemed 1,800,000 The breakage revenue is equal to the proportion of the value of certificates redeemed to the expected value of certificates to be redeemed multiplied by the expected value of breakage. Breakage revenue (1,800,000/4,500,000 x 500,000) 200,000 Journal entries: 1. To record the sale of gift certificates: Cash 5,000,000 Deferred Revenue – gift certificates 5,000,000 2. To record the value of certificates redeemed: Deferred Revenue – gift certificates 1,800,000 Sales 1,800,000 3. To record the breakage revenue: Deferred Revenue – gift certificates 200,000 Breakage Revenue 200,000 REFUNDABLE DEPOSITS (Valix, Peralta, & Valix, 2023) Refundable deposits consist of cash or property received from customers but are refundable after compliance with certain conditions. The best example of a refundable deposit is the customer deposit required for returnable containers like bottles, drums, tanks, and barrels. Illustrative Example 8: RC Company received a deposit of P20,000 from the customer for returnable containers. The containers cost P18,000. Entry to record the receipt of the deposit: Cash 20,000 Containers’ deposit 20,000 Assume the customer returns the containers: Containers’ deposit 20,000 Cash 20,000 Assume the customer fails to return the containers: Containers’ deposit 20,000 Containers 18,000 Gain on sale of containers 2,000 02 Handout 1 *Property of STI  [email protected] Page 8 of 11  BM2403 BONUS COMPUTATION (Valix, Peralta, & Valix, 2023) Large companies often compensate key officers and employees through a 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 entity's success. This compensation plan results in liability that must be measured and reported in the financial statements. Usually, there are four (4) variations in computing for bonus. It can be a percentage of income: Before bonus and before tax; After bonus but before tax; After bonus and after tax; or After bonus and before tax. Illustrative Example 9: Pepsi Company uses the following data to compute its employees' bonuses for year 2X19. Income before bonus and before tax 2,200,000 Bonus 10% Income tax rate 30% NOTE: The answers are rounded off to the nearest whole number. Case 1 - Before bonus and before tax Income before bonus and before tax 2,200,000 Multiply by 10% Bonus 220,000 Case 2 - After bonus and before tax 𝐵 =.10 (2,200,000 − 𝐵) 𝐵 = 220,000 −.10𝐵 𝐵 +.10 𝐵 = 220,000 1.10 𝐵 = 220,000 𝐵 = 220,000/1.10 𝑩 = 𝟐𝟎𝟎, 𝟎𝟎𝟎 To check: Income before bonus and before tax 2,200,000 Less: Bonus 200,000 Income after bonus but before tax 2,000,000 Multiply by 10% Bonus 200,000 Case 3 - After bonus and after tax 𝐵 =.10 (2,200,000 − 𝐵 − 𝑇) 𝑇 =.30(2,200,000 − 𝐵) 𝐵 =.10 [2,200,000 − 𝐵 −.30(2,200,000 − 𝐵)] 𝐵 =.10 (2,200,000 − 𝐵 − 660,000 +.30𝐵) 𝐵 = 220,000 −.10𝐵 − 66,000 +.03𝐵) 1.07𝐵 = 154,000 𝐵 = 154,000/1.07 𝑩 = 𝟏𝟒𝟑, 𝟗𝟐𝟓 02 Handout 1 *Property of STI  [email protected] Page 9 of 11  BM2403 𝑇 =.30 (2,200,000 − 143,925) 𝑻 = 𝟔𝟏𝟔, 𝟖𝟐𝟑 To check: Income before bonus and before tax 2,200,000 Less: Bonus 143,925 Tax 616,823 Income after bonus but before tax 1,439,253 Multiply by 10% Bonus 143,925 Case 4 - After tax but before bonus 𝐵 =.10 (2,200,000 − 𝑇) 𝑇 =.30(2,200,000 − 𝐵) 𝐵 =.10 [2,200,000 −.30(2,200,000 − 𝐵)] 𝐵 =.10 (2,200,000 − 660,000 +.30𝐵) 𝐵 = 220,000 − 66,000 +.03𝐵. 97𝐵 = 154,000 𝐵 = 154,000/.97 𝑩 = 𝟏𝟓𝟖, 𝟕𝟔𝟑 To check: Income before bonus and before tax 2,200,000 Less: Tax (2,200,000 – 158,763 x 30%) 612,371 Income after bonus but before tax 1,587,629 Multiply by 10% Bonus 158,763 DEFERRED REVENUE (Valix, Peralta, & Valix, 2023) Deferred revenue or unearned revenue is income received in advance but not yet earned. It may be realized within one (1) year or more than a year from the end of the reporting period. It is a current liability if it is realizable within a year. On the contrary, if it is realizable for more than a year, it should be classified as a noncurrent liability. Examples of current deferred revenue are unearned interest income, unearned rental, and unearned subscription, while examples of noncurrent deferred revenue are long-term service contracts and long-term leasehold advances. Illustrative Example 10: Java Corporation hired RC Plowing to plow its parking lot and paid P5,000 in advance so that RC would give the company first plowing priority throughout the winter months. At the time of payment, RC has not yet earned the revenue, so it records all P5,000 in a deferred revenue account using the following journal entry: Cash 5,000 Deferred Revenue 5,000 RC expects to plow for Java for five (5) months, so it elects to recognize P1,000 of the monthly deferred revenue. To journalize this transaction, RC records the following entry each month to recognize earned revenue: 02 Handout 1 *Property of STI  [email protected] Page 10 of 11  BM2403 Deferred revenue 1,000 Plowing revenue 1,000 References Kieso, D. E., Weygandt, J. J., Warfield, T. D., Young, N. M., Wiecek, I. M., & McConomy, B. J. (2016). Intermediate Accounting 11th Ed. John Wiey & Sons Canada, Ltd. Robles, N. S., & Empleo, P. M. (2016). Intermediate Accounting Volume 1. Millenium Books, Inc. Valix, C. T., Peralta, J. F., & Valix, C. A. (2023). Immediate Accounting 2. GIC Enterprises & Co., Inc. 02 Handout 1 *Property of STI  [email protected] Page 11 of 11