AUDIT OF LIABILITIES

REFINANCING AND BREACH OF CONTRACT (PAS 1)

Refinancing: Generally, a currently maturing obligation has to be presented as current liability.
A currently maturing obligation may be presented as a long-term liability under refinancing agreement, only if:
1. The company has the prerogative/option/unconditional right to refinance the liability OR
2. If there is no right but the refinancing agreement was completed before or at the balance sheet date.
Note: Refinancing may be thru:
a. Extension of maturity date
b. Issuance of stocks or bonds the proceeds of which is used to settle the currently maturing obligation
Breach of Contract: Generally, if the company breaches a covenant or contract the long-term obligation becomes due and demandable, thus is
presented as short-term liability. The obligation mar still be presented as long-term only under the ff conditions:
1. If the creditor agreed to give the debtor a grace period for at least 12 months after the balance sheet date, AND
2. The said grace period should have been provided on or before the balance sheet date
ESTIMATED LIABILITIES/PROVISONS (PAS 37)
- A liability whose either amount or timing is uncertain
Accrued, under the ff conditions:
1. Present obligation (legal or constructive)resulting from a past event or transaction (obligation event should have happened on or
before the balance sheet date)
2. It is probable that an outflow of economic benefits will be required to settle the obligation
3. The amount of obligation should be capable of being reliably measures

Common examples of provisions are: Product warranties and guarantees, Premiums and coupon obligations, Liability from litigations,
Guarantee of liability of others, Provisions from onerous contracts, Unlawful environmental damages

FOR ESTIMATED LIABILITIES FOR PREMIUMS/WARRANTIES/COUPONS

Total expense, per estimation policy xx

Less: actual cost incurred to date (xx)
*Provisions/Estimated Liability at year end xx
Note: for premiums, expense and liability shall be net cost (cost of premiums + additional processing costs – collections made/to be made prior
to distribution if there are any)

*Before accruing liability at year end, consider if all provision/estimated liability are still valid, that is, are still probable to be settled in the next
period (e.g., if warranty, consider warranty period, if GCP consider validity period,etc.)
REIMBURSEMENTS OF PROBABLE LOSSES UNDER PAS 37
– these are amounts expected to be received as reimbursements if entity settles the provision. Reimbursements shall be accounted for as
follows:
a. If the entity has no obligation for the part of the expenditure to be reimbursed, the reimbursable amount shall be deducted
against the losses recognized in the income statements. The liability shall be presented in the balance sheet net of the
reimbursable amount.
b. If the obligation for the amount expected to be reimbursed remains with the entity and reimbursement is VIRTUALLY CERTAIN,
the reimbursements shall be accrued as an asset (receivable) in the balance sheet any may be offset against the losses
recognized in the income statement. The amount recognized for the expected reimbursement should not exceed the liability.
c. IF the obligation for the amount expected to be reimbursed remains with the entity and the reimbursements is not virtually
certain, the expected reimbursement is not recognized as an asset. The expected reimbursement may be disclosed.
CONTINGENT LIABILITIES
1. Possible obligation whose existence is to be determined in the future contingent upon the happening of a future event; or
2. Present obligation, but is not accrued because it is either remotely possible that economic benefits will be required to settle the
obligation and/or the amount of the obligation is not capable of being reliably measured
FOR BONDS PAYABLE PROBLEMS:
Bonds issued at a discount (Proceeds<Face value; Effective Interest>Nominal Interest)
 Discount is a transaction loss (amount received/proceed is lower than the amount to be paid/face value)to be amortized over the
remaining term of the bonds using the EFFECTIVE INTEREST METHOD
 The amortization is added to the related expense – INTEREST EXPENSE
Interest Expense xx
Discount on Bonds Payable xx
As a result of the amortization, the interest expense recognized in the income statement is higher than the interest paid and/or accrued. The
difference is the amount of amortization
 Correct interest is computed as : (Carrying value of Bonds * Effective Interest)
 Nominal Interest is computes as: (Face Value of Bonds * Nominal Interest)
Bonds issued at a premium (Proceeds>Face value; Effective Interest<Nominal Interest)
 Premium is a transaction gain (amount received/proceed is higher than the amount to be paid/face value) to be amortized over the
remaining term of the bonds using the effective interest method
 The amortization is deducted from the related expense – interest expense
Discount on Bonds Payable xx
Interest Expense xx
AUDIT OF LIABILITIES
 As a result of the amortization, the interest expense recognized in the income statement is lower than the interest paid/accrued. The
difference is the amount of amortization.
Bond Issue Cost - are deducted from net cash proceeds, thus in the process are deducted from premium or added to discount on bonds
payable (after which a new effective interest rate shall be computed)
RETIREMENT OF BONDS – if bonds are retired prior to their maturity dates, gain or loss shall be recognized in the profit/loss (difference
between the retirement price and updated amortized cost of the bonds plus accrued interest, where applicable)
Accrued Interest - in accounting for bond issuance and retirement, consider inclusion of accrued interest specifically if bonds were issued or
retire in between interest payment dates.
CONVERTIBLE BONDS
1. ISSUANCE – proceeds from the issuance of Convertible Bonds should be allocated between the debt component (bonds payable) and
the equity component (Share Premium form Bond Conversion Privilege) using the residual approach. To wit, the pro-forma entry to
record issuance is:
Cash xx
Discount on bonds payable xx
Premium on bonds payable xx
Bonds Payable xx
Share premium from Bonds Conv. Privilege xx
2. CONVERSION – if convertible bonds are converted into ordinary shared, the carrying value of the bonds (updated amortized bonds
payable) shall be cancelled out. The difference between the carrying value of the bonds and the aggregate par value of the converted
shares shall be credited to share premium account. An allowed alternative is the cancel out the equity component originally credited
to share premium account upon issuance of the bonds. The same shall be added to the amount credited to the share premium
account upon conversion. To wit, the pro-forma entry to record the conversion is:
Alternative 1 Alternative 2
Bonds payable xx Bonds payable xx
Premium on Bonds Payable xx Share premium from Bonds Conv. Privilege xx
Discount on Bonds Payable xx Premium on Bonds Payable xx
Ordinary Shares xx Discount on Bonds Payable xx
Share Premium xx Ordinary Shares xx
Share Premium xx

3. EARLY RETIREMENT – if convertible bonds are retired prior to maturity date, the retirement price shall be allocated between the
bonds and the equity component, consisted with how the original issue price was allocated (residual approach). The difference
between the retirement price of the allocated to the debt component and the carrying value of the bonds payable shall be
recognized in the income statement, while the difference between the retirement price allocated to the equity component and the
original share premium from bond conversion privilege shall be credited to share premium account
BONDS PAYABLE WITH WARRANTS (see warrants accounting in SHE)
FOR LEASE PROBLEMS:
 Leases are generally operating unless FINANCE under specific criteria/requirements under PAS 17:
a. Transfer of ownership to lessee
b. Bargain purchase option
c. Term at least 75% of life of asset
d. PV of minimum lease payments (MLP) is at least 90% of the FMV of the leased asset
e. The asset is specialized in nature that only lessee can use with very minimal alterations
OPERATING LEASE (guidelines)
a. Lease payments including lease bonuses shall be recognized as expense (lessee) or income (lessor) over the lease term on the
straight line basis, unless a more systematic method is warranted
b. Lease escalation clauses, provisions for lease/rental holidays and uneven rental payments built into the lease contract must be
accounted for on a straight line basis, unless a more systematic method is warranted
c. Contingent rentals are recognized as expense (lessee) or income (lessor) when incurred/earned
d. Lease security deposits are generally treated as receivable/other asset (lessee) or payable (lessor)
e. Direct lease expense (paid for by lessor) are either recognized as outright expense or as a deferred charged(added to the CV of
leased asset, and amortized as expenses over lease term
f. Usual routinary lease related expense (depreciation, property taxes, maintenance costs) are generally incurred by lessor and are
recognized as outright expense
FINANCE LEASE (guidelines, books of lessee)
 Upon inception, if payments are made in arrears (at the end of each lease period)
Asset (at FV/PV of MLP, whichever is lower) xx
Finance lease liability xx
Or, if payments are made in advance (at the beginning of each lease period)
Asset (at FV/PV of MLP, whichever is lower) xx
Cash xx
Finance lease liability xx
 Upon periodic payments

Interest Expense (CV of liab*eff%) xx

AUDIT OF LIABILITIES
Finance Lease Liability (balancing figure) xx
Cash xx
 Year-end depreciation, shall be computed as: (Depreciable cost/lease term or useful life)
Depreciable Cost shall be: Cost – Actual Residual value or Guaranteed Residual value (where applicable), whichever is lower.
Lease term is used if there is no transfer of ownership, while useful life is appropriate if ownership is transferred to lessee.
AUDIT PROGRAM FOR ACCOUNTS PAYABLE
Audit Objectives:
To determine that:
1. Accounts payable represent amounts currently payable to trade creditors for purchases of goods and services as at the end of the
reporting period.
2. Accounts payable have been properly recorded
3. Accounts payable are properly described and classified and adequate disclosures have been made

Audit Procedures:

1. Obtain a list of accounts payable from the subsidiary ledger, and:

 Check its footing
 Check if the list reconciles with the general ledger control account
 Trace individual balances to the subsidiary ledger
 Test accuracy of balances in the subsidiary ledger
 Adjust non-trade accounts erroneously included in supplier’s accounts
 Investigate and reclassify significant debit balances

2. Confirm accuracy of individual balances appearing in the subsidiary ledger by requesting statements of accounts from suppliers, and:
 Reconcile supplier’s statement if accounts with client records and investigate any discrepancy
 If suppliers do not respond with the requests, perform extended procedures, like:
o Reviewing payments after year-end
o Checking supporting documents
o Discussing the account with appropriate officer
3. Review correspondence with suppliers for possible adjustments
4. Test propriety of cutoff:
 Examine purchases recorded and supplier’s deliveries made a week before and after the end of the reporting period and
ascertain whether the purchases were recorded in the proper period
5. Ascertain whether some payables are secured with asset pledges
6. Compare payments after the reporting date with year-end schedule of accounts payable
7. Review propriety of financial statement presentation and adequacy of disclosures
8. Perform analytical review
9. Obtain accounts payable representation letter

AUDIT PROGRAM FOR NONCURRENT LIABILITIES

Audit Objectives:
To determine:
1. Authorization of liabilities incurred
2. Validity of recorded liabilities
3. Recognition and recording of significant liabilities
4. Compliance with terms, restrictions, conditions and other requirements of debt agreements
5. Assets pledged or mortgaged and other guarantees related to noncurrent liabilities are identified
6. Accuracy of interest and other charges related to noncurrent liabilities
7. Propriety of financial statement presentation and adequacy of disclosures

Audit Procedures:

1. Obtain schedule/s of noncurrent liabilities, indicating:  Additions during the year

As to general nature:  Repayments or renewals during the year
 Description or nature of the noncurrent  Balance at year-end
liabilities
As to interest
 Creditor/s
 Original principal amount  Accrued or prepaid at the beginning of the
 Interest rate year
 Collateral and/or guarantees  Amount incurred the year
 Terms, restrictions, conditions and  Payments during the year
requirements imposed by the creditors  Accrued or prepaid at year-end
As to principal amount outstanding 2. Foot and cross-foot the schedule
3. Verify accuracy of the schedule
 Beginning-of-the-year balance As to general nature:
AUDIT OF LIABILITIES
 Obtain copies or excerpts of debt instruments o Establish accuracy by an
and trace data to the schedule independent computation based in
debt instruments
As to principal amount outstanding: o Trace to beginning ledger balances
 Trace beginning balances to last year’s  Recompute the interest
working papers, or in initial audit, establish o Incurred
accuracy of beginning balances by: o Accrued
o Reference to debt instruments and o Prepaid
prior year’s recordings  Trace payments to cash records and canceled
o Tracing to beginning ledger balances checks
 Trace proceeds to cash receipts records for 4. Verify authorizations by reference to minutes of the
new liabilities incurred in the current year board of directors’ meetings
 Trace payments to cash disbursements records 5. Confirm directly with the creditors or trustees the ff:
and canceled checks 6. Determine client’s compliance with loan agreements
 Vouch to supporting documents the renewals 7. Account for the used and unused debt instruments like
in the current year bond certificates and promissory notes
 Agree working paper ending balances with the 8. Ascertain proper cancelation of paid or retired debt
general ledger accounts instruments
9. Recompute the accuracy of any discount or premium
As to interest:
amortization
 Trace beginning balances to last year’s
working papers, or in initial audit:
10. Reconcile interest payments with recorded liabilities
11. Verify propriety of financial statement presentation and adequacy of disclosures

I. You were provided the ff information relative to your audit of the financial statements of Victoria Company as at December 31,
2018
Employee income tax withheld P900.00
Cash balance at First Philippine Bank 2 500.00
Cash Overdraft at Second Philippine Bank 1 350.00
Accounts receivable with credit balances 2 850.00
Estimated expenses of meeting warranties on merchandise sold 3 200.00
Estimated damages on unsatisfactory performance on a contract 1 250.00
Accounts payable 29 750.00
Dividends in arrears on preference shares 25 000.00
Deferred serial bonds of P500 000.00, issued at par, payable in semi-annual installments of P50 000.00,
due April 1 and October 1 of each year; the last payment shall be in October 2024. These serial bonds
bear a 10% interest that is paid semiannually.
Ordinary shares at par to be distributed as a result of a share dividend declaration 40 000.00
Deferred tax liabilities expected to reverse next year 10 000.00
Reserve for contingencies 50 000.00
1. At year end, how much should be presented as current liabilities? P 51 800.00
2. How much is the total of the non-current liabilities? P 510 000.00
II. During 2018, Cory Company introduced a new line of machines that carries a two-year warranty against manufacturer’s defects.
Based on industry experience, the estimated warranty cost percentages related to peso sales are as follows:
Year of sale 4%
Year after sale 6%

Sales and actual warranty expenditures for the year ended Dec 31 2017 and 2018 were as follows:

Year Sales Actual warranty expenditures

2017 500 000.00 P 15 000.00
2018 700 000.00 47 000.00

1. Warranty expense to be recognized in 2017 and 2018; respectively? P 50 000 and P70 000.00
2. Estimated warranty liability as of Dec 31, 2017? P35 000.00
3. Estimated warranty liability as of Dec 31, 2018? P58 000.00