Question

Drew-Richards iMusic is a regional music media reseller. As a promotion, it offered $5 cash rebates on specific CDs. Customers must mail in a proof-of-purchase seal from the package plus the cash register receipt to receive the rebate. Experience suggests that 70% of the rebates will be claimed Twenty thousand of the CDs were sold in the rebates will be claimed. Twenty thousand of the CDs were sold in 2013. Total rebates to customers in 2013 were $22,000 and were recorded as promotional expense when paid. The fiscal year ends on December 31.

1.What is the promotional expense that Drew-Richards should report in its 2013 income statement?
2. What is the premium liability that Drew-Richards should report in its 2013 balance sheet?
3. Prepare the appropriate journal entry to record the contingency.

Answer 1

The promotional expense for Drew-Richards iMusic in 2013 is $22,000 as paid out in rebates. The premium liability to report on the 2013 balance sheet is $48,000, which is the remaining estimated rebate obligation after deducting rebates already paid. Appropriate journal entries must reflect these figures to record the contingency.

Step-by-step explanation:

The promotional expense that Drew-Richards should report in its 2013 income statement is based on the actual amount paid out in rebates, which is $22,000. This is because expenses are recorded when they are paid, according to the cash basis of accounting. However, if the accrual method is used, the estimated total rebate expense, based on experience, would be also taken into account.

As for the premium liability, since 70% of the rebates are expected to be claimed, and 20,000 CDs were sold, the expected rebate would be for 14,000 CDs (70% of 20,000). At $5 per CD, the total rebate liability would be $70,000 (14,000 CDs * $5), but since $22,000 has already been paid, the remaining premium liability to report on the balance sheet would be $48,000 ($70,000 - $22,000).

The journal entry at the end of 2013 to record the contingency, assuming no rebates have been paid yet, would be:

• Debit Promotional Expense for $70,000
• Credit Premium Liability for $70,000

If some rebates have been paid, the journal entry to record the remaining estimated liability would be the difference between the total liability and what has already been paid.