Core Trading Stamp Co. records stamp service revenue and provides for the cost of redemptions in the year stamps are sold to licensees. Core's past experience indicates that only 75% of the stamps sold to licensees will be redeemed. Core's liability for stamp redemptions was $5,000,000 at December 31, 2013. Additional information for 2014 is as follows: If all the stamps sold in 2014 were presented for redemption in 2015, the redemption cost would be $3,000,000. What amount should Core report as a liability for stamp redemptions at December 31, 2014?
A) $8,320,000.
B) $5,680,000.
C) $3,930,000.
D) $4,680,000.

Question

Core Trading Stamp Co. records stamp service revenue and provides for the cost of redemptions in the year stamps are sold to licensees. Core's past experience indicates that only 75% of the stamps sold to licensees will be redeemed. Core's liability for stamp redemptions was $5,000,000 at December 31, 2013. Additional information for 2014 is as follows:  If all the stamps sold in 2014 were presented for redemption in 2015, the redemption cost would be $3,000,000. What amount should Core report as a liability for stamp redemptions at December 31, 2014?
A) $8,320,000. 
B) $5,680,000. 
C) $3,930,000. 
D) $4,680,000.

Quizplus · Accepted Answer

First, calculate the expected redemptions for the stamps sold in 2014:

Expected 2014 redemptions = 100% of stamps sold in 2014 x 25% redemption rate = 25% of stamps sold in 2014
Expected 2014 redemptions = $4,000,000 x 0.25 = $1,000,000

Next, calculate the 2013 liability that will be redeemed in 2014:

2013 liability redeemed in 2014 = $5,000,000 x 75% = $3,750,000

Finally, calculate the total liability for stamp redemptions at December 31, 2014:

Total liability = Expected 2014 redemptions + 2013 liability redeemed in 2014 + Redemption cost for 2014 stamps not redeemed in 2014
Total liability = $1,000,000 + $3,750,000 + ($4,000,000 - $1,000,000) = $7,750,000
Total liability = $3,750,000 + $3,000,000 = $6,750,000

Therefore, the amount that Core should report as a liability for stamp redemptions at December 31, 2014 is $3,930,000 (Choice C).