Question

Garison Music Emporium carries a wide variety of musical instruments, sound reproduction equipment, recorded music, and sheet music. Garison uses two sales promotion techniques—warranties and premiums—to attract customers.

Musical instruments and sound equipment are sold with a 1-year warranty for replacement of parts and labor. The estimated warranty cost, based on past experience, is 2% of sales.

The premium is offered on the recorded and sheet music. Customers receive a coupon for each dollar spent on recorded music or sheet music. Customers may exchange 200 coupons and \(20 for an MP3 player. Garison pays \)32 for each player and estimates that 60% of the coupons given to customers will be redeemed.

Garison’s total sales for 2017 were \(7,200,000—\)5,700,000 from musical instruments and sound reproduction equipment and \(1,500,000 from recorded music and sheet music. Replacement parts and labor for warranty work totaled \)94,000 during 2017. A total of 6,500 players used in the premium program were purchased during the year and there were 1,200,000 coupons redeemed in 2017.

The balances in the accounts related to warranties and premiums on January 1, 2017, were as shown below.

Inventory of Premiums $ 37,600

Premium Liability 44,800

Warranty Liability 136,000

Instructions

Garison Music Emporium is preparing its financial statements for the year ended December 31, 2017. Determine the amounts that will be shown on the 2017 financial statements for the following.

(a) Warranty Expense. (d) Inventory of Premiums.

(b) Warranty Liability. (e) Premium Liability.

(c) Premium Expense

Short answer

(a) Warranty expense equals $114,000.

(b) Warranty liability equals $62,000.

(c) Premium expense equals $54,000.

(d) Inventory of premiums equals $53,600

(e) Premium liability equals $26,800

Step-by-step solution

(a) Calculation of warranty expense

Particulars	Amount
Actual cost	$94,000
Add: Estimated cost as of Dec.31,2017 (($5,700,000 x 2%)-$94,000)	$20,000
Warranty expense	$114,000

(b) Calculation of warranty liability

Particulars	Amount
Estimated liability for the Beginning of 2017	$136,000
Add: Warranty expense for 2017	20,000
Subtotal	$156,000
Less: Actual warranty cost incurred	($94,000)
Estimated warranty liability	$62,000

(c) Calculation of premium expense

Particulars	Amount
Number of coupons issued (A) ($1,500,000 / 1 coupon)	1,500,000
Redemption rate (B)	0.60
Estimated coupons to be redeemed (C)= (AxB)	900,000
Exchange rate (Coupons per player) (D)	200
Estimated number of premium players (E) = (C / D)	4,500
Net cost of players ($32-$20) (F)	$12
Premium expense (E x F)	$54,000

(d) Calculation of inventory of premiums

Particulars	Amount
Inventory of premiums, Beginning 2017	$37,600
Add: Premium players purchased in 2017 (6,500 x$32)	$208,000
Premium players available	$245,600
Less: Coupons exchanged ((1,200,000 / 200) x $32)	$192,000
Inventory of premiums	$53,600

(e) Calculation of premium liability

Particulars	Amount
Estimated liability for premiums, Beg. Balance	$44,800
Add: Premium expense of 2017	$54,000
Subtotal	$98,800
Less: Redemptions in 2017 ((1,200,000/200) x ($32-$20))	$72,000
Premium liability	$26,800