Mullen Music Limited (MML) carries a wide variety of musical instruments, sound reproduction equipment, recorded music, and sheet music. MML uses two sales promotion techniques-warranties and premiums-to attract customers.
Musical instruments and sound equipment are sold with a one-year warranty for replacement of parts and labour. The estimated warranty cost, based on experience, is 2% of sales.
A 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 plus $20 for a CD player. MML pays $34 for each CD player and estimates that 60% of the coupons given to customers will be redeemed.
MML's total sales for 2014 were $7.2 million: $5.4 million from musical instruments and sound reproduction equipment, and $1.8 million from recorded music and sheet music. Replacement parts and labour for warranty work totalled $164,000 during 2014. A total of 6,500 CD players used in the premium program were purchased during the year and there were 1.2 million coupons redeemed in 2014.
The expense approach is used by MML to account for the warranty and premium costs for financial reporting purposes. The balances in the accounts related to warranties and premiums on January 1, 2014, were:
Inventory of premiums ............................... $ 39,950
Estimated liability for premiums ...................... 44,800
Warranty Liability ..................................... 136,000
Instructions
(a) MML is preparing its financial statements for the year ended December 31, 2014. Determine the amounts that will be shown on the 2014 financial statements for the following:
1. Warranty expense
2. Warranty Liability
3. Premium expense
4. Inventory of premiums
5. Estimated liability for premiums
(b) Assume that MML's auditor determined that both the one-year warranty and the coupons for the CD players were, in fact, revenue arrangements with multiple deliverables that should be accounted for under the revenue approach. Explain how this would change the way in which these two programs were accounted for in part (a).