Premiums and Coupons Offered to Customers
The term premiums and coupons refers to promotions by companies offered to customers such as redeemable certificates, rebates, box tops, and cash discounts. Premiums and coupons are categorized as contingency losses, since they require a future event to trigger the liability.
Current liabilities are defined as debts that must be paid within one year or one operating cycle, whichever is longer. In order to be classified as contingent, the debt obligation depends on one or more future events to confirm the amount owed.
As is the case with all contingent liabilities, if the likelihood of the future event is probable, and the obligation can be reasonably estimated, the company should accrue the expense and place the current liability on their balance sheet.
Premiums and coupons are issued to increase sales, and the company's marketing department would create a business case outlining not only the impact on revenues, but also an estimate of the redemption rate by customers. A confirmation of the liability would be created when a customer actually redeems their coupon or collects their premium.
Company A's marketing department would like to clear out some of the company's existing inventory of smartphones in advance of the launch of a new product line in October. Company A will be offering a $50 cash back rebate in the month of September to customers purchasing one of their older smartphones.
Company A's marketing department believes the company will sell approximately 100,000 smart phones in the month of September, and 70% of customers will apply for, and receive, the $50 rebate.
The contingent liability created by this coupon would be calculated as:
|Smartphones Sold in September (units)||100,000|
|Percentage of Customers Receiving the $50 Rebate||70%|
|Number of $50 Rebates Issued||70,000|
|Estimated Cost of Promotion (Rebates Issued x $50)||$3,500,000|
The journal entry in September to account for premiums and coupons would then be:
|Current Liability (Cash Rebates)||$3,500,000|
Note: Company A would also be required to make subsequent adjusting entries if the redemption rate and unit sales did not align with the estimates provided by their marketing department.