Chapter 9, Problem 20E

1.

To determine

Prepare the journal entries in the books of Company TC for 2016.

Explanation of Solution

Prepare the journal entry to record the purchase of the toy trucks:

Date	Account Titles and Explanations	Debit ($)	Credit ($)
2016	Inventory of premiums	300,000
	Cash $\left(240,000\times \$1.25\right)$		300,000
	(To record the purchase of toy trucks)

Table (1)

Prepare the journal entry to record the sales:

Date	Account Titles and Explanations	Debit  ($)	Credit ($)
2016	Cash or accounts receivable	9,000,000
	Sales $\left(5,000,000\times \$1.80\right)$		9,000,000
	(To record the sales)

Table (2)

Prepare the journal entry to record the estimate of total premium liability:

Date	Account Titles and Explanations	Debit ($)	Credit ($)
2016	Premium expenses (2)	75,000
	Estimated premium liability		75,000
	(To record the recognition of estimated premium liability)

Table (3)

Working note (1):

Calculate the total box tops estimated for redemption:

Particulars	Amount ($)	Amount ($)
Total box tops outstanding in 2016 (A)	5,000,000
Estimated percent redeemed (B)	60%
Total coupons estimated for redemption (C) $\left(\text{A}\times \text{B}\right)$		$3,000,000

Table (4)

Working note (2):

Calculate the amount of premium expenses:

$\begin{array}{c}\text{Premium expense = }\left[\begin{array}{l}\frac{\text{Total coupons estimated for redemption}}{\text{Offer of a toy truck upon return of 10 coupons}}\\ \times \left(\begin{array}{l}\text{Cost of a toy truck}-\text{Collection of cash}\\ \text{from customers on redemption of 10 coupons}\end{array}\right)\end{array}\right]\\ =\frac{3,000,000\text{coupons}}{10}\times \left(\$1.25-\$1.00\right)\\ =\$75,000\end{array}$

Prepare the journal entry to record the redemption of 2,200,000 coupons in 2016:

Date	Account Titles and Explanations	Debit ($)	Credit ($)
2016	Cash $\left(\frac{2,200,000}{10}\times \$1\right)$	220,000
	Estimated premium liability $\left(\frac{2,200,000}{10}\times \$0.25\right)$	55,000
	Inventory of premiums     $\left(\frac{2,200,000}{10}\times \$1.25\right)$		275,000
	(To record the redemption of 2,200,000 coupons)

Table (5)

2.

To determine

Identify the manner in which the items related to premium plan would be reported in the balance sheet as of December 31, 2016.

Explanation of Solution

Balance sheet: Balance Sheet is one of the financial statements that summarize the assets, the liabilities, and the Shareholder’s equity of a company at a given date. It is also known as the statement of financial status of the business.

Prepare the partial balance sheet as of December 31, 2016.

Company TC
Balance Sheet Statement (Partial)
As at December 31, 2016
Assets	Amount
Current assets:
Inventory of premiums (3)	$25,000
Liabilities	Amount
Current liabilities:
Estimated premium liability (4)	$20,000

Table (6)

Working note (3):

Determine the amount of inventory premium as at December 31, 2016.

$\begin{array}{c}\begin{array}{l}\text{Inventory of premium}\\ \text{at December 31, 2016}\end{array}\}\text{= }\left[\begin{array}{l}\text{Increase (debit) in inventory of premium in 2016 }-\\ \text{Decrease (credit) in inventory of premium in 2016 }-\end{array}\right]\\ =\$300,000-\$275,000\\ =\$25,000\end{array}$

Working note (4):

Determine the amount of estimated premium liability as at December 31, 2016.

$\begin{array}{c}\begin{array}{l}\text{Estimated premium liability}\\ \text{at December 31, 2016}\end{array}\}\text{= }\left[\begin{array}{l}\text{Increase (credit) in estimated}\\ \text{premium liability in 2016 }-\\ \text{Decrease (debit) in estimated}\\ \text{premium liability in 2016 }-\end{array}\right]\\ =\$75,000-\$55,000\\ =\$20,000\end{array}$

3.

To determine

Explain the effects on the financial statements if Company TC recorded the premium expense as the coupons were redeemed.

Explanation of Solution

Effects on the financial statements:

The premium was offered by Company TC to increase the sales and the redemption of coupons is probable and that can be reasonably estimated. Thus, Company TC must record the estimate as an expense and the related liability during the sales period. If the estimate is not made, then the expenses will not match properly against the sales premium. As an effect of this Company TC’s expense would be understated by $20,000. In addition to this, Company TC’s liability will not properly reflect the probable obligation of the company. Thus, Company TC’s liability will be understated by $20,000.