 Hello and welcome to this session in which we would look at an exercise or a CPA simulation that deals with premium liability. Let's start this exercise. Clean solutions is a cleaning product manufacturers that include one coupon in each box of dishwashing detergent that it packs. The company offers a promotion where a customer can redeem 10 of those coupons for a free softener box. Simply put for each with each box of dishwashing detergent you will get one coupon. You collect 10 of those and you can exchange them for a softener box. In 20x1 clean solution purchase 10,000 boxes of those softeners at 75 cents each and we purchase 10,000. We sold 150,000 boxes of dishwashing detergent at $4.20 per box. During the year 50,000 coupons were presented for redemption and it's estimated that 60% of all coupons will eventually be presented for redemption. We're going to answer a series of questions. It's first what's the cost of premium purchased in 20x1, the revenue earned from the sale of dishwashing detergent, the liability for the premium redeemed in 20x1, the liability for unredeemed coupon at the end of x1 and the estimated liability for future redemption based on the percentage of coupon expected to be redeemed. Before we proceed any further I have a public announcement about my company farhatlectures.com. Farhat accounting lectures is a supplemental educational tool that's going to help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of lectures, multiple-choice questions, true-false questions as well as exercises. Go ahead start your free trial today, no obligation, no credit card required. Starting with the cost of premium purchased we purchased 10,000 of those boxes, 10,075 each, the total cost of the premium is 7,500, we will debit premium inventory or simply inventory and we credit cash and this is to purchase now we have 10,000 boxes of those bounce, the box after. Next we're going to compute the revenue earned from the sale of the dishwashing detergent, well we sold 150,000 units at 420 each, total sales is 630,000, the entry is debit cash, we're going to assume we sold them for cash, credit inventory, we are going to ignore the cost of goods sold. Now with this sale, the 150,000 sale comes the coupons because now customers are going to collect the coupons and we sold 150,000 so there are 150,000 outstanding coupons. Now in 20x1 we were told 50,000 of these were redeemed, 50,000 divided by 10 it means we have to give 5,000 boxes of bounces, well liability for premium redeemed 5,000 times 75 cent each is 3,750, we debit premium expense because now we're gonna we're gonna send these out for free basically not for free as a redemption well it's an expense for us they're not giving us anything in return and we're gonna credit inventory. Now in total we were expect we there are 150,000 of those coupons outstanding we estimate 60 percent to be redeemed in other words we estimate 90,000 in total to be redeemed of those 90,000 50,000 were already redeemed it means we still have 40,000 of coupons of potential potentially to be redeemed based on our estimate 40,000 that's gonna give us an additional 4,000 boxes of softener that will need that will need to go outside the door. Now this is all assumption this is all estimate well if we still have to give up 4,000 it means we still have 3,000 of an expense of future expense that we're gonna have to incur in future period but we have to record this expense now why because we sold 150,000 unit in year x1 the expense that goes with those sales has to be recorded in year x1 in other words we already recorded how much of the expense 3,750 of those expenses on the previous slide now we need to record an additional 3,000 of these expenses because these expenses really are related to the sale that took place in x1 therefore we have to comply with the matching principle so therefore we have to debit an expense now we're not given anything out yet we're just debiting an expense we're gonna credit a liability because it's our obligation to give those boxes out now eventually in year x2 we're gonna assume in year x2 people came back and they indeed they redeemed the 4,000 the i'm sorry the 40,000 coupons and we have to give them the 3,000 the 4,000 boxes of softener which cost us 3,000 dollar now we debit the liability now we are reducing our liability and we credit inventory premium which is 3,000 dollar now let's take a look at the inventory premium and see what happened here you remember inventory premium we purchased 7,500 of those on the prior slide on the prior slide we redeemed 3,750 3,750 and now we redeemed 3,000 so let's take 7,500 minus 3,750 minus 3,000 we still have 750 dollars worth of boxes of those softener boxes now why did we over buy why did we over buy literally literally we over buy by 10 percent because the original amount was an estimate that that that 60 percent here was an estimate now what can we do maybe we can sell those we can sell those remaining 1,000 boxes for a dollar let's assume we sold each one for a dollar we're going to debit cash because we still have 1,000 boxes for a dollar we're going to credit sales for a dollar then we're going to credit cost of goods sold for 750 and credit premium inventory for 750 750 and now we got rid of all those boxes just in case you're wondering it doesn't add up to 7,500 it's not going to you just estimated you purchase 7,500 just to make sure in case more people came back because remember we said 150,000 we estimated only 60 percent to be redeemed okay which is 60 percent which is 9,000 coupon now there's no reason that 120,000 could be redeemed we'll have to go back and buy more under those circumstances the point is it's an estimate so keep that in mind also keep in mind that we have to match the expense with the revenue and remember we have to book a liability against that expense because the expense we're recording the expense now based on some sort of an estimate so it's an expense liability until that liability is met which is in year I would assume in year x2 they came back and redeemed those coupons an important concept this is an important concept how you accrue a liability how you reduce the liability what should you do now go to far hat lectures look at additional mcqs true false additional lectures that's going to help you understand these concepts better whether you are studying for your cpa cma accounting certification or simply put continuous profession professional education invest in yourself