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01b Provisions Contingencies PDF
01b Provisions Contingencies PDF
Estimated liabilities are obligations which exist at the end of reporting period although the
amount is not definite. In many cases, the date when the obligation is due is not also definite
and in some instances, the exact payee cannot be identified or determined. But in spite of
these circumstances, the existence of the estimated liabilities is valid and unquestioned.
Estimated liabilities are either current or noncurrent in nature. Examples include estimated
liability for premium, award points, warranties, gift certificates and bonus. Actually, an
estimated liability is considered as a "provision" which is both probable and measurable.
Paragraph 11 of PAS 37 states that provision can be distinguished from other liabilities,
such as trade payables and accruals, because there is uncertainty about the timing of amount
of the future expenditure required in settlement. In contrast, there is certainty about the
timing or amount of trade payables and accruals.
PAS 37, paragraph 14, states that a provision shall be recognized as liability under the
following conditions:
1. The entity has a present obligation as a result of a past event.
2. It is probable that an outflow of economic benefits shall be required to settle the
obligation.
3. The amount of the obligation can be measured reliably.
For a provision to qualify for recognition, there must be not only a present obligation but also
a probable outflow of resources embodying economic benefits to settle the obligation. An
outflow of resources is regarded as "probable" if the event is more likely than not to occur,
meaning, the probability that the event will occur is greater than the probability that it will not
occur. As a rule of thumb, "probable" means more than 50% likely.
The amount recognized as a provision should be the best estimate of the expenditure
required to settle the present obligation at the end of reporting period. The best estimate is
the amount that an entity would rationally pay to settle the obligation at the reporting date or
to transfer it to a third party at that time. Where a single obligation is being measured, the
individual most likely outcome may be the best estimate. However, even in such a case, the
entity shall consider other possible outcomes. Where there is a continuous range of possible
outcomes and each point in that range is as likely as any other, the midpoint of the range is
used.
This is the statistical method of estimation applied where the provision being measured
involves a large population of items. Under this method, the obligation is estimated by
"weighting" all possible outcomes by their associated possibilities.
a. The risks and uncertainties that inevitably surround many events and circumstances
shall be taken into account in reaching the best estimate of a provision.
b. Where the effect of the time value of money is material, the amount of provision" shall
be the present value of the expenditures expected to be required to settle the obligation.
c. Future events that affect the amount required to settle an obligation shall be reflected in
the amount of a provision where there is a sufficient objective evidence that they will
occur. Examples of such future events include new legislation and changes in
technology.
d. Gains from expected disposal of assets shall not be taken into account in measuring a
provision.
e. Where some or all of the expenditure required to settle a provision is expected to be
reimbursed by another party, the reimbursement shall be recognized when it is virtually
certain that reimbursement will be received if the entity settles the obligation.
The reimbursement shall be treated as a separate asset and not "netted" against the
estimated liability for the provision.
The amount shall not exceed the amount of the provision. However, in the income
statement, the expense relating to the provision may be presented net of the
reimbursement.
f. Provisions shall be reviewed at each reporting date and adjusted to reflect the current
best estimate.
g. A provision shall be used only for expenditures for which the provision was originally
recognized.
h. Provision shall not be recognized for future operating losses.
i. If an entity has an onerous contract, the present obligation under the onerous contract
shall be recognized and measured as a provision.
An onerous contract is a contract in which the unavoidable costs of meeting the obligation
under the contract exceed the economic benefits expected to be received under the contract.
PAS 37, paragraph 68, mandates that the unavoidable costs under a contract represent the
"least net cost of exiting from the contract". Such cost is the lower amount between the cost
of fulfilling the contract and the compensation or penalty arising from failure to fulfill the
contract.
1. Warranty. The best estimate of the warranty cost is recognized as a provision because
in this case there is clear legal obligation arising from an obligating event which is the
sale of the product with warranty.
2. Environmental contamination. If an entity has an environmental policy such that other
parties would expect the entity to clean up any contamination, or if the entity has broken
current environmental legislation, a provision for environmental, damage shall be made.
The obligating event is the contamination of the property which gives rise to constructive
or legal obligation. A provision is recognized for the best estimate of the cost of cleaning
up the contamination.
3. Decommissioning or abandonment cost. When an oil entity initially purchases an oil
field, it is put under a legal obligation to decommission the site at the end of its life. The
cost of abandonment or decommissioning shall be recognized as a provision and may
be capitalized as cost of the oil field.
4. Court case. After a wedding in the current year, ten people died possibly as a result of
food poisoning from products sold by the entity. Legal proceedings are started seeking
damages from the entity. When the entity prepares the financial statements for the
current year, its lawyers advise that owing to the development in the case, it is probable
that the entity would be found liable. A provision is recognized for the best estimate of
the damages because on the basis of available evidence, there is a present obligation.
5. Guarantee. In the current year, an entity gives a guarantee of certain borrowings of
another entity. During the year, the financial condition of the borrower deteriorates and
at year-end, the borrower files a petition for bankruptcy. A provision is recognized for
the best estimate of the guarantee obligation because there is a legal obligation arising
from the obligating event which is the guarantee. It is probable that an outflow of
resources embodying economic benefits would be required to settle the guarantee
obligation because there is a petition for bankruptcy on the part of the borrower.
PAS 37, paragraph 10, defines restructuring as a "program that is planned and controlled by
management and materially changes either the scope of a business of an entity or the manner
in which that business is conducted".
Examples of events that may qualify as restructuring include:
a. Sale or termination of a hne of business.
b. Closure of business location in a region or relocation of business activities from one
location to another.
c. Change in management structure, such as elimination of a layer of management.
d. Fundamental reorganization of an entity that has a material and significant impact on the
operations.
A constructive obligation for restructuring arises when two conditions are present:
1. The entity has a detailed formal plan for the restructuring outlining at least the business
or part of the business being restructured, the principal location affected, the location,
function and approximate number of employees who will be compensated for terminating
their employment, when the plan will be implemented, and the expenditures that will be
undertaken.
2. The entity has raised valid expectation in the minds of those affected that the entity will
carry out the restructuring by starting to implement the plan and announcing its main
features to those affected by it.
A restructuring provision shall include only direct expenditures arising from the restructuring,
meaning, those expenditures that are necessarily entailed by the restructuring and not
associated with the ongoing activities of the entity. For example, salaries and benefits of
employees to be incurred after operations cease and that are associated with the closure of
the operations shall be included in the amount of the restructuring provision.
PAS 37, paragraph 81, specifically excludes the following expenditures from the restructuring
provision:
a. Cost of retraining or relocating continuing staff.
b. Marketing or advertising program to promote the new entity image.
c. Investment in new system and distribution network.
Premiums are articles of value such as toys, dishes, silverware, and other goods and in some
cases cash payments, given to customers as result of past sales or sales promotion activities.
In order to stimulate the sale of their products, entities offer premiums to customers in return
for product labels, box tops, wrappers and coupons. Accordingly, when the merchandise in
sold, an accounting liability for the future distribution of the premium arises and should be
given accounting recognition.
Product Warranty
17. Explain an estimated warranty liability.
Home appliances like television sets, stereo sets, ratio sets, refrigerators and the like are
often sold under guarantee or warranty to provide free repair service or replacement during
a specified period if the products are defective. Such entity policy may involve significant
costs on the part of the entity if the products sold prove to be defective in the future within the
specified period of time. Accordingly, at the point of sale, a constructive obligation arises and
a liability is incurred.
Contingent Liability
18. What is a contingent liability?
c. Remote - The future event is least likely to occur or the chance of the future event
occurring is very slight.
The second definition of contingent liability states that a contingent liability is a present
obligation. However, the present obligation is either probable or measurable but not both to
be considered a contingent liability. If the present obligation is both probable and
measurable, it is not a contingent liability but a provision to be recognized in the financial
statements.
A contingent liability shall not be recognized in the financial statements but shall be disclosed
only.
Required disclosures in relation to contingent liability
a. Brief description of the nature of the contingent liability
b. An estimate of its financial effects
c. An indication of the uncertainties that exist
d. Possibility of any reimbursement
If the contingent liability is remote, no disclosure is necessary.
Contingent Asset
22. What is a contingent asset?
PAS 37, paragraph 10, defines a contingent asset as a "possible asset that arises from past
event and whose existence will be confirmed by the occurrence or nonoccurrence of one or
more uncertain future events not wholly within the entity's control". A contingent asset shall
not be recognized because this may result to recognition of income that may never be
realized. However, when the realization of income is virtually certain, the related asset is no
longer contingent asset and its recognition is appropriate. A contingent asset is only
disclosed when it is probable. Required disclosures in relation to contingent asset
a. Brief description of the contingent asset.
b. An estimate of the financial effect.
If a contingent asset is only possible or remote, no disclosure is required.
MCQ - Theory
Provision
1. Which is the correct definition of a provision?
A. A liability of uncertain timing or amount
B. An obligation to transfer funds to an entity
C. A liability which cannot be easily measured
D. A possible obligation arising from past events FA 2 © 2014
2. A legal obligation is an obligation that is derived from all of the following, except
A. A contract
B. Legislation
C. Other operation of law
D. An established pattern of past practice FA 2 © 2014
6. It is a contract in which the unavoidable costs of meeting the obligation under the contract
exceed the economic benefits to be received under the contract.
A. Executed contract C. Onerous contract
B. Executory contract D. Sale contract FA 2 © 2014
7. It is the abusive practice of manipulation and creative accounting by dumping all kinds of
provisions under the banner of provision for restructuring.
A. Big bath provision C. Creative accounting
B. Cookie jar D. General reserve FA 2 © 2014
19. When the provision arises from a single obligation, the estimate of the amount
A. Midpoint of the possible outcomes.
B. Is determined as the individual most likely outcome.
C. Reflects the weighting of all possible outcomes by their associated probabilities.
D. Is the individual most likely outcome adjusted for the effect of other possible outcomes.
20. Where there is a continuous range of possible outcomes, and each point in that range is as
likely as any other, the range to be used is the
A. Midpoint
B. Minimum
C. Maximum
D. Summation of the minimum and maximum FA 2 © 2014
21. Which of the following statements is true concerning the measurement of a provision?
I. The amount recognized as a provision should be the best estimate of the expenditure
required to settle the present obligation at the end of reporting period.
II. The best estimate of the expenditure required to settle the present obligation is the
amount that an entity would rationally pay to settle the obligation at the end of reporting
period or to transfer it to a third party at that time.
A. I only C. Both I and II
B. II only D. Neither I nor II FA 2 © 2014
22. Which of the following statements is true in relation to the measurement of a provision?
I. The risks and uncertainties that inevitably surround many events and circumstances
shall be taken into account in reaching the best estimate of a provision.
II. Where the effect of the time value of money is material, the amount of a provision shall
be the present value of the expenditure expected to settle the obligation.
A. I only C. Both I and II
B. II only D. Neither I nor II FA 2 © 2014
24. Which of the following statements is incorrect where some or all of the expenditure required
to settle a provision is expected to be reimbursed by another party?
A. The amount of the reimbursement shall not exceed the amount of the provision.
B. The reimbursement shall be "netted" against the estimated liability for the provision.
C. In the income statement, the expense relating to the provision may be presented net of
the reimbursement.
D. The reimbursement shall be recognized only when it is virtually certain that the
reimbursement will be received if the entity settles the obligation. FA 2 © 2014
25. Provisions shall be discounted if the effect is material. Which of the following is incorrect
regarding the discount rate?
A. Is a post-tax discount rate
B. Reflects risk specific to the liability.
C. Reflects current market assessment of the time value of money. FA 2 © 2014
D. Does not reflect risk for which future cash flow estimates have already been adjusted.
26. This is defined as "a structured program that is planned and controlled by the management
that materially changes either the scope of a business of an entity or the manner in which
that business is conducted".
A. Corporate revamp C. Recapitalization
B. Liquidation D. Restructuring FA 2 © 2014
27. Examples of events that qualify as restructuring include all of the following, except
A. Sale or termination of business
B. Change in management structure such as elimination of a layer of management
C. Closure of business location in a region or relocation of business from one location to
another
D. Fundamental reorganization of an entity that has an immaterial and insignificant impact
on its operations. FA 2 © 2014
30. How should incurred costs associated with relocating employees in a restructuring be
accounted for?
A. Recognized when costs are paid.
B. Measured at fair value and recognized over two years.
C. Measured at fair value and treated as prior period error.
D. Measured at fair value and recognized when the liability is incurred. FA 2 © 2014
31. An entity is closing one of its operating divisions, and the conditions for making restructuring
provision have been met. The closure will happen in the first quarter of the next financial year.
At the current year-end, the entity has announced the formal plan publicly and is calculating
the restructuring provision. Which of the following costs should be included in the
restructuring provision?
A. Retraining staff continuing to be employed
B. Relocation costs relating to staff moving to other divisions
C. Future operating losses of the division being closed up to the date of closure
D. Contractually required costs of retraining staff being made redundant from the division
being closed FA 2 © 2014
32. The board of directors of an entity decided in the latter part of the current year to wind up
international operations in the Far East and move them to Australia. The decision was based
on a detailed formal plan of restructuring as required by PAS 37. This decision was conveyed
to all workers and management personnel at the headquarters in Europe. The.cost of this
restructuring plan can be measured reliably. How should the entity treat this restructuring in
the financial statements for the current year-end? FA 2 © 2014
A. Mention the decision to restructure and the cost involved in the chairman's statement in
the annual report since it is a decision of the board of directors.
B. Because the restructuring has not commenced before year-end, based on prudence,
wait until next year and do nothing in this year's financial statements.
C. Recognize a provision for restructuring since the board of directors has approved it and
it has been announced in the headquarters of the entity in Europe.
D. Disclose only the restructuring decision and the cost of restructuring because the entity
has not announced the restructuring to those affected by the decision and thus has not
raised an expectation that the entity would actually carry out the restructuring.
33. An entity operates chemical plants. Its published policies include a commitment to making
good any damage caused to the environment by its operations. It has always honored this
commitment. Which of the following scenarios relating to the entity would give rise to an
environmental provision?
A. The government has outlined plans for a new law requiring all environmental damage to
be rectified.
B. A chemical spill from one of the entity's plants has caused harm to the surrounding area
and wildlife.
C. Recent research suggests there is a possibility that the entity's actions may damage
surrounding wildlife.
D. On past experience it is likely that a chemical spill which would result in having to pay
fines and penalties will occur in the next year. FA 2 © 2014
Product Warranty
35. The accrual approach in accounting for product warranty cost
A. Is required for income tax purposes.
B. Is frequently justified on the basis of expediency when warranty cost is immaterial.
C. Finds the expense account being charged when the seller performs in compliance with
the warranty.
D. Represents accepted practice and should be used whenever the warranty is an integral
and inseparable part of the sale. FA 2 © 2014
36. Which of the following best describes the accrual approach of accounting for warranty cost?
A. Expensed when paid.
B. Expensed when incurred.
C. Expensed based on estimate in year of sale.
D. Expensed when warranty claims are certain. FA 2 © 2014
37. Which of the following best describes the expense as incurred approach of accounting for
warranty cost?
A. Expensed when incurred.
B. Expensed when liability is accrued.
C. Expensed when warranty claims are certain.
D. Expensed based on estimate in year of sale. FA 2 © 2014
38. An entity has a continuing policy of guaranteeing new products against defects for three
years. What is the classification of the estimated warranty liability?
A. Current C. Noncurrent FA 2 © 2014
B. No need for disclosure D. Partly current and partly noncurrent
39. An entity sells appliances that include a three-year warranty. Service calls under the warranty
are performed by an independent mechanic under a contract with the entity. Based on
experience, warranty costs are expected to be incurred for each machine sold. When should
the entity recognize these warranty costs?
A. When the machines are sold
B. Evenly over the life of the warranty
C. When the service calls are performed
D. When payments are made to the mechanic AICPA 1194
40. An entity sells furnaces that include a three-year warranty. The entity can contract with a
third party to provide these warranty services. The entity elects the fair value option for
reporting financial liabilities. At what amount should the entity report the warranty liability?
A. The cost of expected warranty services
B. The present value of expected warranty costs
C. The fair value of the contract to settle the warranty services
D. The fair value of the contract less the cost to provide the services Wiley 2011
41. Which of the following is a characteristic of the accrual of warranty but not the sale of
warranty?
A. Warranty expense C. Warranty revenue
B. Warranty liability D. Unearned warranty revenue FA 2 © 2014
Contingent liability
42. A contingent liability is
A. An estimated liability.
B. A potential large liability.
C. A potential small liability.
D. An event which is not recognized because it is not probable that an outflow will be
required or the amount cannot be reliably estimated. FA 2 © 2014
43. Contingent liabilities will or will not become actual liabilities depending on
A. The degree of uncertainty.
B. The outcome of a future event.
C. Whether they are probable and estimable.
D. The present condition suggesting a liability. FA 2 © 2014
49. Which of the following is not considered when evaluating whether or not to record a liability
for pending litigation?
A. The type of litigation involved.
B. The probability of an unfavorable outcome.
C. Time period in which the underlying cause of action occurred.
D. The ability to make a reliable estimate of the amount of the loss. FA 2 © 2014
53. A present obligation that is probable and for which the amount can be reliably estimated shall
A. Be accrued by debiting an expense account and crediting a liability account.
B. Not be accrued but shall be disclosed in the notes to the financial statements.
C. Be accrued by debiting an appropriated retained earnings account and crediting a liability
account.
D. Be accrued by debiting an expense account and crediting an appropriated retained
earnings account. FA 2 © 2014
54. An entity has a self-insurance plan. Each year, the entity appropriated retained earnings for
contingencies in an amount equal to insurance premiums saved less recognized losses from
lawsuits and other claims. As a result of an accident in the current year, the entity is a
defendant in a lawsuit in which it will probably have to pay measurable amount of damages.
What are the effects of this lawsuit's probable outcome on the entity's financial statements
for the current year?
A. No effect on either expenses or liabilities
B. An increase in both expenses and liabilities
C. An increase in expenses and no effect on liabilities
D. No effect on expenses and an increase in liabilities FA 2 © 2014
55. An entity did not record an accrual for a present obligation but disclose the nature of the
obligation and the range of the loss. How likely is the loss?
A. Certain C. Reasonably possible
B. Probable D. Remote FA 2 © 2014
56. How should a contingent liability be reported in the financial statements when it is reasonably
possible that the entity will have to pay the liability at a future date?
A. As a disclosure only
B. As a deferred liability
C. As an accrued liability FA 2 © 2014
D. As an account payable with an additional disclosure explaining the nature of the
transaction
57. A competitor has sued an entity for unauthorized use of its patented technology. The amount
that the entity may be required to pay to the competitor if the competitor succeeds in the
lawsuit is determinable with reliability, and according to the legal counsel it is less than
probable but more than remote that an outflow of the resources would be needed to meet the
obligation. The entity that was sued shall at year-end
A. Recognize a provision for this possible obligation.
B. Make a disclosure of the possible obligation in footnotes to the financial statements.
C. Set aside, as an appropriation, a contingency reserve, an amount based on the best
estimate of the possible liability.
D. Make no provision or disclosure and wait until the lawsuit is finally decided and then
expense the amount paid on settlement, if any. FA 2 © 2014
58. Which of the following should be disclosed in the financial statements as a contingent liability?
A. The entity has not yet paid certain claims under sales warranties.
B. The entity has received a letter from a supplier complaining about an old unpaid invoice.
C. The entity is involved in a legal case which it may possibly lose, although this is not
probable.
D. The entity has accepted liability prior to the year-end for unfair dismissal of an employee
and is to pay damages. FA 2 © 2014
59. The likelihood that the future event will or will not occur can be expressed by a range of
outcome. Which range means that the future event occurring is very slight?
A. Certain C. Reasonably possible
B. Probable D. Remote FA 2 © 2014
61. An entity has been served a legal notice at year-end by the Department of Environment and
Natural Resources to fit smoke detectors in its factory on or before middle of the next year.
The cost of fitting smoke detector can be measured reliably. How should the entity treat this
in its financial statements at year-end?
A. Ignore the event.
B. Recognize a provision for the current year equal to the estimated amount.
C. Recognize a provision for the current year equal to one-half only of the estimated
amount.
D. No provision is recognized at year-end because there is no present obligation for the
future expenditure since the entity can avoid the future expenditure by changing the
method of operations, but disclosure is required. FA 2 © 2014
Contingent assets
63. It is a possible asset that arises from past event and whose existence will be confirmed only
by the occurrence or nonoccurrence of one or more uncertain future events not wholly within
the control of the entity.
A. Asset in suspense C. Contingent gain
B. Contingent asset D. Possible asset FA 2 © 2014
65. Which of the following is the proper way to report a contingent asset, receipt of which is
virtually certain?
A. As a disclosure only C. As unearned revenue FA 2 © 2014
B. As an asset D. No disclosure and no accrual
66. A factory owned by an entity was destroyed by fire. The entity lodged an insurance claim for
the value of the factory building and plant, and an amount equal to one year's net profit.
During the year, there were a number of meetings with the representatives of the insurance
company. Finally, before year-end, it was decided that the entity would receive compensation
for 90% of its claim. The entity received a letter that the settlement check for that amount had
been mailed but it was not received before year-end. How should the entity treat this in the
financial statements?
A. Disclose the contingent asset in the footnotes.
B. Record 90% of the claim as a receivable as it is virtually certain that the contingent asset
will be received.
C. Wait until next year when the settlement check is actually received and not recognize
this receivable at all since at year-end it is a contingent asset.
D. Record 100% of the claim as a receivable at year-end as it is virtually cetain that the
contingent asset will be received, arid adjust the 10% next year when the settlement
check is actually received. FA 2 © 2014
67. When the occurrence of a contingent asset is probable and the amount can be reasonably
estimated, the contingent asset should be
A. Classified as an appropriation of retained earnings.
B. Recognized in the statement of financial position and disclosed.
C. Disclosed but not recognized in the statement of financial position.
D. Neither recognized in the statement of financial position nor disclosed. FA 2 © 2014
68. Which of the following is the proper accounting treatment of a probable contingent asset?
A. A disclosure only
B. Deferred earnings
C. An accrued account
D. An account receivable with an additional disclosure explaining the nature of the
transaction
69. At year-end, an entity was suing a competitor for patent infringement. The award from the
probable favorable outcome could be reasonably estimated. The entity's financial statements
should report the expected award as
A. Disclosure only C. Receivable and reduction of patent
B. Receivable and deferred revenue D. Receivable and revenue FA 2 © 2014
72. An entity operates a plant in a foreign country. It is probable that the plant will be expropriated.
However, the foreign government has indicated that the entity will receive a definite amount
of compensation for the plant. The amount of compensation is less than the fair value but
exceeds the carrying amount of the plant. The contingent asset should be reported
A. In the statement of financial position
B. In the notes to the financial statements
C. As a fixed asset valuation allowance account
D. As a valuation allowance as part of shareholders' equity FA 2 © 2014
73. Gain contingencies that are remote and can be reliably measured
A. Must be reported.
B. May be disclosed.
C. Must be disclosed.
D. Should not be reported or disclosed. FA 2 © 2014
Disclosures
74. Which of the following is required to be disclosed regarding risk and uncertainties that exist?
A. Factor causing an estimate to be sensitive.
B. A description of operations both within and outside of the home country.
C. The potential impact of estimate when it is remotely possible that the estimate will change
in the future.
D. The potential impact of estimate when it is reasonably possible that the estimate will
change in the future. FA 2 © 2014
MCQ - Problems
Provisions - Composition
1. Iriga Company issued the 2013 financial statements on March 1,2014. The following data are
provided by the entity for the year ended December 31,2013:
Amount owing to another entity for services rendered during December 2013 300,000
Estimated long service leave owing to employees in respect of past services 1,200,000
Estimated cost of relocating an employee from head office to a
branch in another city (employee will physically relocate in January 2014) 100,000
Estimated cost of overhauling machine every 5 years
(the machine is 5 years old on December 31, 2013) 150,000
What amount should be recognized as provision on December 31, 2013?
A. 1,200,000 C. 1,600,000
B. 1,300,000 D. 1,750,000
3. Las Palmas Company included one coupon in each package of cereal sold. A towel is offered
as a premium to customers who send in 10 coupons. Data for the premium offer are:
2014 2015
Packages of cereal sold 500,000 800,000
Number of towels purchased at P40 per towel 30,000 60,000
Number of towels distributed as premium 20,000 50,000
Number of towels to be distributed as premium next period 5,000 3,000
What amount should be reported as premium expense for 2015?
A. 1,920,000 C. 2,120,000
B. 2,000,000 D. 2,400,000 FA 2 © 2014
5. On January 1, 2014, Roca Company began marketing a new soft drink. To help promote the
soft drink, the management is offering a special gift, a T-shirt, to each customer who returns
10 bottle caps. The entity estimated that out of the 250,000 bottles sold in 2014, only 80%
will be redeemed. On December 31, 2014, the following information was collected:
Units Amount
T-shirts purchased 18,000 1,800,000
T-shirts distributed 15,000
What is the estimated premium liability on December 31, 2014?
A. 200,000 C. 500,000
B. 300,000 D. 700,000 FA 2 © 2014
6. Clam Company offers its customers a pottery cereal bowl if they send in three boxtops from
its products and P10. The entity estimated that 60% of the boxtops will be redeemed. In 2014,
the entity sold 675,000 boxes and customers redeemed 330,000 boxtops receiving 110,000
bowls. The cost of each bowl is P25. What is the liability for outstanding premiums on
December 31, 2014?
A. 250,000 C. 625,000
B. 375,000 D. 875,000 FA 2 © 2014
7. At the beginning of current year, Daisy Company began marketing a new beer called
"Serbesa". To help promote the product, the management is offering a special Serbesa beer
mug to each customer for every 20 specially marked bottle caps of Serbesa. The entity
estimated that out of the 300,000 bottles of Serbesa sold during the year, only 50% of the
marked bottle caps would be redeemed. During the year, the entity purchased 8,000 beer
mugs at a total cost of P360.000 or P45 each and had already distributed 4,500 mugs to
customers. What is the estimated premium liability at year-end?
A. 135,000 C. 337,500
B. 202,500 D. 360,000 FA 2 © 2014
8. Topsy Company started a new promotional program. For every 10 box tops returned,
customers receive a basketball. The entity estimated that only 60% of the box tops reaching
the market will be redeemed. Additional information is as follows:
Units Amount
Sales of product 100,000 30,000,000
Basketball purchased 5,500 4,125,000
Basketball distributed 4,000
What is the amount of year-end estimated liability associated with this promotion?
A. 1,500,000 C. 4,125,000
B. 3,000,000 D. 4,500,000 FA 2 © 2014
9. Bare Company included one coupon in each box of laundry soap it sold. A towel is offered
as a premium to customers who send in 10 coupons and a remittance of P20. Data for the
premium offer are:
2014 2015
Boxes of soap sold 500,000 800,000
Number of towels purchased (P100 per towel) 20,000 25,000
Coupons redeemed 140,000 200,000
The entity's experience indicated that only 30% of the coupons will be redeemed.
What amount should be reported as estimated premium liability on December 31, 2015?
A. 80,000 C. 400,000
B. 320,000 D. 500,000 FA 2 © 2014
10. In an effort to increase sales, Blue Company inaugurated a sales promotion campaign on
June 30, 2014, whereby the entity placed a coupon in each package of razor blades sold, the
coupons being redeemable for a premium. Each premium costs P50 and five coupons must
be presented by a customer to receive a premium. The entity estimated that only 60 percent
of the coupons issued will be redeemed. For the six months ended December 31, 2014, the
following information is available:
Packages of razor blades sold 400,000
Premiums purchased 30,000
Coupons redeemed 100,000
What is the estimated liability for premium claims outstanding on December 31, 2014?
A. 1,000,000 C. 1,800,000
B. 1,400,000 D. 2,400,000 FA 2 © 2014
11. During 2014, Day Company sold 500,000 boxes of cake mix under a new sales promotional
program. Each box contained one coupon, which entitled the customer to a baking pan upon
remittance of P40. The entity paid P50 per pan and P5 for handling and shipping.
The entity estimated that 80% of the coupons will be redeemed, even though only 300,000
coupons had been processed during 2014.
What amount should be reported as liability for unredeemed coupons on December 31,
2014?
A. 1,000,000 C. 3,000,000
B. 1,500,000 D. 5,000,000 FA 2 © 2014
12. In packages of the products, Curran Company included coupons that may be presented at
retail stores to obtain discounts. Retailers are reimbursed for the face amount of coupons
redeemed plus 10% of that amount for handling costs. The entity granted requests for coupon
redemption by retailers up to three months after the consumer expiration date. The entity
estimated that 70% of all coupons issued will ultimately be redeemed.
Consumer expiration date December 31, 2014
Total face amount of coupons issued 600,000
Total payments to retailers as of December 31,2014 220,000
What amount should be reported as liability for unredeemed coupons on December 31,
2014?
A. 0 C. 242,000
B. 200,000 D. 308,000 FA 2 © 2014
13. Cereal Company frequently distributes coupons to promote new products. On October 1,
2014, the entity mailed 100,000 coupons for P45 off each box of cereal purchased and
expected 12,000 of these coupons to be redeemed before the December 31, 2014 expiration
date. It takes -30 days from the redemption date for the entity to receive the coupons from
the retailers. The entity reimburses the retailers an additional P5 for each coupon redeemed.
On December 31, 2014, the entity had paid retailers P250,000 related to these coupons and
had 5,000 coupons on hand that had not been processed for payment.
What amount should be reported as liability for coupons on December 31, 2014?
A. 225,000 C. 290,000
B. 250,000 D. 350,000 FA 2 © 2014
14. Energy Company offered a cash rebate of P10 on each P40 package of batteries sold during
2013. Historically, 10% of customers mail in the rebate form. During 2013, 6,000,000
packages of batteries are sold, and 210,000 P10 rebates are mailed to customers. What
amount of rebate expense and liability for rebates should be reported respectively, on
December 31,2013?
A. 2,100,000 and 3,900,000 C. 6,000,000 and 3,900,000
B. 3,900,000 and 3,900,000 D. 6,000,000 and 6,000,000 P1 @ 2013
Product Warranty
15. Mile Company sells washing machines that carry a three-year warranty against
manufacturer's defects. Based on entity experience, warranty costs are estimated at P300
per machine. During the current year, the entity sold 2,400 washing machines and paid
warranty costs of P170,000. What amount should be reported as warranty expense for the
current year?
A. 170,000 C. 550,000
B. 240,000 D. 720,000 FA 2 © 2014
16. East Company manufactures stereo systems that carry a two-year warranty against defects.
Based on past experience, warranty costs are estimated at 5% of sales for the warranty
period. During the current year, stereo system sales amounted to P5,000,000 and warranty
costs of P100,000 were incurred. What amount should be reported as warranty expense for
the current year?
A. 100,000 C. 150,000
B. 125,000 D. 250,000 FA 2 © 2014
17. Erwin Company offers a three-year warranty on the products sold. The entity previously
estimated warranty costs to be 2% of sales. Due to a technology advance in production at
the beginning of 2014, the entity now believed 1% of sales to be a better estimate of warranty
costs. Warranty costs of P80,000 and P96..000 were reported in 2012 and 2013, respectively.
Sales for 2014 amounted to P5,000,000. What amount should be reported as warranty
expense for 2014?
A. 50,000 C. 100,000
B. 88,000 D. 138,000 FA 2 © 2014
18. Chato Company sells electrical goods covered by a one-year warranty for any defects. Of the
sales of P70,000,000 for the year, the entity estimated that 3% will have major defect, 5%
will have minor defect and 92% will have no defect. The cost of repairs would be P5,000,000
if all the products sold had major defect and P3,000,000 if all had minor defect. What amount
should be recognized as a warranty provision?
A. 190,000 C. 5,600,000
B. 300,000 D. 8,000,000 FA 2 © 2014
19. Toyo Company owns a car dealership that it uses for servicing cars under warranty. In
preparing its financial statements, the entity needs to ascertain the provision for warranty that
it would be required to provide at the end of the year.
The entity's experience with warranty claims is as follows: 60% of all cars sold in a year have
zero defect, 25% of all cars sold in a year have normal defect, and 15% of all cars sold in a
20. Bizarre Company gives warranties at the time of sale to purchasers of its product. The entity
undertakes to make good, by repair or replacement, manufacturing defects that become
apparent within one year from the date of sale. Sales of P10,000,000 were made evenly
throughout 2013. The expenditures for warranty repairs and replacements for the products
sold in 2013 are expected to be made 50% in 2013 and 50% in 2014. The 2014 outflows of
economic benefits related to the warranty will take place on June 30,2014.
The entity estimated that 95% of products sold require no warranty repairs, 3% of products
sold require minor repairs costing 10% of the sale price, and 2% of products sold require
major repairs or replacement costing 90% of sale price.
The appropriate discount factor for cash flows expected to occur on June 30,2014 is 0.95.
An appropriate risk adjustment factor to reflect the uncertainties in the cash flow estimates is
an increment of 6% to the probability-weighted expected cash flows. What is the warranty
provision on December 31,2013?
A. 105,735 C. 210,000
B. 111,300 D. 222,600 P1 @ 2013
21. Humanizer Company gives warranties at the time of sale to purchasers of its product. Under
the terms of the sale, the entity undertakes to make good, by repair or replacement,
manufacturing defects that become apparent within one year from the date of sale.
On December 31,2013, the entity appropriately recognized P50,00C warranty provision. The
entity incurred and charged P140,000 against the warranty provision in 2014. Out of the PI
40,000, an amount of P80,000 related to warranties for sales made in 2014. The increase
during 2014 in the discounted amount recognized as a provision on December 31,2013
arising from the passage of time is P2,000.
On December 31, 2014, the entity estimated that it would incur expenditures in 2015 to meet
its warranty obligations on December 31, 2014 as follows:
5% probabihty of P400,000
20% probability of P200,000
50% probability of P 80,000
25% probability of P 20,000
Assume for simplicity that the 2015 cash flows for warranty repairs and replacements take
place on June 30,2015.
An appropriate discount rate is 10% per year. The PV of 1 at 10% for one year is 0.91 and
the PV of 1 at 10% for 6 months is 0.95. An appropriate risk adjustment factor to reflect the
uncertainties in the cash flow estimates is an increment of 8% to the probability-weighted
expected cash flows.
What is the warranty expense to be recognized in 2014?
A. 107,730 C. 187,730
B. 185,000 D. 195,730 P1 @ 2013
22. Villa Company estimated annual warranty expense at 8% of net sales. The following data
relate to the current year:
Net sales ?
Warranty liability, January 1
Before adjustment 100,000 debit
After adjustment 540,000 credit
What is the amount of net sales for the current year?
A. 1,250,000 C. 6,750,000
B. 5,500,000 D. 8,000,000 FA 2 © 2014
23. On April 1, 2014, Ash Company began offering a new product for sale under a one-year
warranty. Of the 5,000 units in inventory at April 1, 2014, 3,000 had been sold by June 30,
2014. Based on its experience with similar products, the entity estimated that the average
warranty cost per unit sold would be P80. Actual warranty costs incurred from April 1 through
June 30, 2014, were P70.000. On June 30, 2014, what amount should be reported as
estimated warranty liability?
A. 90,000 C. 170,000
B. 160,000 D. 330,000 FA 2 © 2014
24. Bold Company estimated annual warranty expense at 2% of annual net sales. The net sales
for the current year amounted to P4,000,000. On January 1, 2014, the warranty liability was
P60,000 and the warranty payments during the year totaled P50,000. What is the warranty
liability on December 31, 2014?
A. 10,000 C. 80,000
B. 70,000 D. 90,000 FA 2 © 2014
25. Bass Company manufactures high-end home electronic systems. The entity provided a one-
year warranty for all products sold. The entity estimated that the warranty cost is P200 per
unit sold and reported a liability for estimated warranty cost of P650,000 on January 1, 2014.
During the current year, the entity sold 5,000 units for a total of P2,450,000 and paid warranty
claims of P750,000 on current and prior year sales. What amount of warranty liability should
be reported on December 31, 2014?
A. 250,000 C. 750,000
B. 350,000 D. 900,000 FA 2 © 2014
26. During 2014, Rex Company introduced a new product carrying a two-year warranty against
defects. The estimated warranty costs related to peso sales are 2% within 12 months
following sale and 4% in the second 12 months following sale. Sales are P6,000,000 for 2014
and Pi0,000,000 for 2015. Actual warranty expenditures are P90,000 for 2014 and P300,000
for 2015. On December 31, 2015, what is the estimated warranty liability?
A. 0 C. 450,000
B. 100,000 D. 570,000 FA 2 © 2014
27. In 2014, Dubious Company began selling new line of products that carry a two-year warranty
against defects. Based upon past experience with other products, the estimated warranty
costs related to peso sales are as follows:
First year of warranty 2%
Second year of warranty 5%
Sales and actual warranty expenditures are presented below:
2014 2015
Sales 5,000,000 7,000,000
Actual warranty costs 100,000 300,000
What is the estimated warranty liability on December 31, 2015?
A. 390,000 C. 490,000
B. 440,000 D. 840,000 FA 2 © 2014
Dismantling cost
28. Dubai Company purchased an oil rig for P5,000,000 on January 1, 2014. The life of the rig is
10 years and the expected cost to dismantle the rig at the end of 10 years is P1,000,000. The
appropriate discount rate for the entity is 10%. The present value of the dismantling cost at
10% is P385,000. What expense should be recorded in the current year as a result of these
events?
A. Depreciation expense of P600,000.
B. Depreciation expense of P500,000 and interest expense of P38,500.
C. Depreciation expense of P538,500 and interest expense of P38,500.
D Depreciation expense of P500,000 and interest expense of P100,000. FA 2 © 2014
Restructuring provision
29. Helen Company decided on November 1,2013 to restructure the entity's operations as
follows:
Factory A would be closed down and put on the market for sale.
Employees working in Factory A would be retrenched on November 30,2013, and would
be paid their accumulated entitlements plus six months' wages.
Some employees working in Factory A would be transferred to Factory B, which would
continue operating.
On December 31,2013, the following transactions and events had occurred:
The retrenched employees have left and their accumulated entitlements have been paid.
However, an amount of P1,000,000, representing a portion of the six months' wages for
the retrenched employees, has still not been paid.
Costs of P300,000 are expected to be incurred in transferring the remaining employees
to their new work in Factory B. The transfer is planned for January 15,2014.
One employee, Juan Cruz, remains in order to complete administrative tasks relating to
the closure of Factory A and the transfer of employees to Factory B. Juan Cruz is
expected to stay until January 31,2014. His salary for January will be P50,000 and his
retrenchment package will be P150,000, all of which will be paid on the day he leaves.
Juan Cruz would spend 60% of his time administering the closure of Factory A, 30% on
administering the transfer of employees to Factory B, and the remaining 10% on general
administration.
What total amount should be recognized as restructuring provision on December 31,2013?
A. 1,180,000 C. 1,480,000
B. 1,200,000 D. 1,500,000
What amount should be reported as provision for relocation costs on June 30, 2014?
A. 140,000 C. 240,000
B. 160,000 D. 250,000 FA 2 © 2014
34. Concord Company sells motorcycle helmets. In 2014, the entity sold 4,000,000 helmets
before discovering a significant defect in their construction. By December 31, 2014, two
lawsuits had been filed against the entity. The first lawsuit, which the entity has little chance
of winning, is expected to be settled out of court for P1,500,000 in January 2015.
The attorneys think the entity has a 50-50 chance of winning the second lawsuit which is for
P1,000,000.
What is the accrued liability on December 31, 2014 as a result of the lawsuits?
A. 0 C. 1,500,000
B. 1,000,000 D. 2,500,000 FA 2 © 2014
35. Winter Company is being sued for illness caused to local residents as a result of negligence
on the entity's part in permitting the local residents to be exposed to highly toxic chemicals
from its plant. The entity's lawyer stated that it is probable that the entity will lose the suit and
be found liable for a judgment costing the entity anywhere from P1,200,000 to P6,000,000.
However, the lawyer estimated that the most probable cost is P3,600,000. What amount
should be accrued and disclosed?
A. No loss contingency but disclose a contingency of Pl.200,00.0 to P6,000,000.
B. A loss contingency of P3,600,000 but not disclose any additional contingency.
C. A loss contingency of P3,600,000 and disclose an additional contingency of up to
P2,400,000.
D. A loss contingency of Pi,200,000 and disclose an additional contingency of up to
P4,800,000. FA 2 © 2014
36. On December 31, 2014, Mith Company was a defendant in a pending lawsuit. In the opinion
of the entity's attorney, it is probable that Mith Company will have to pay P500,000 and it is
reasonably possible that Mith Company will have to pay P600,000 as a result of this lawsuit.
What should be reported in the 2014 financial statements?
A. No information about this lawsuit.
B. An accrued liability of P500,000 only.
C. An accrued liability of P600,000 only. FA 2 © 2014
D. An accrued liability of P500,000 and disclosure of a contingent liability of P100,000
37. A Malaysian-based shipping entity lost an entire shipload of cargo valued at P5,000,000 on
a voyage to Australia. It is however covered by an insurance policy. According to the report
of the surveyor, the amount is collectible, subject to the deductible clause in the insurance
policy. Before year-end, the shipping entity received a letter from the insurance entity that a
check was in the mail for 90% of the claim.
The international freight forwarding entity that entrusted the shipping entity with the delivery
of the cargo overseas has filed a lawsuit for P5,000,000, claiming the value of the cargo that
was lost on high seas, and also consequential damages of P2,000,000 resulting from the
delay.
According to the legal counsel for the shipping entity, it is probable that the shipping entity
would have to pay the P5,000,000 but it is a remote possibility that it would have to pay the
additional P2,000,000 claimed by the international freight forwarding entity, since this loss
was specifically excluded in the freight forwarding contract.
What provision should be recognized by the shipping entity at year-end?
A. 0 C. 5,000,000
B. 500,000 D. 7,000,000 P1 © 2013
38. During 2014, Odyssey Company is the defendant in a patent infringement lawsuit. The
entity's lawyers believe there is a 30% chance that the court will dismiss the case and the
entity will incur no outflow of economic benefits. However, if the court rules in favor of the
claimant, the lawyers believe that there is a 20% chance that the entity will be required to pay
damages of P200,000 and an 80% chance that the entity will be required to pay damages of
P100,000. Other outcomes are unlikely. The court is expected to rule in late December 2015.
There is no indication that the claimant will settle out of court. A 7% risk adjustment factor to
the probability-weighted expected cash flows is considered appropriate to reflect the
uncertainties in the cash flow estimates. An appropriate discount rate is 5% per year. The
present value of 1 at 5% for one period is 0.95. What is the measurement of the provision for
lawsuit on December 31, 2014?
A. 84,000 C. 89,880
B. 85,386 D. 100,000 FA 2 © 2014
39. During 2014, Libya Company is the defendant in a breach of patent lawsuit. The lawyers
believe there is an 80% chance that the court will not dismiss the case and the entity will incur
outflow of benefits. If the court rules in favor of the claimant, the lawyers believe that there is
a 60% chance that the entity will be required to pay damages of P2,000,000 and a 40%
chance that the entity will be required to pay damages of PI,000,000. Other amounts of
damages are unlikely. The court is expected to rule within three months. There is no indication
that the claimant will settle out of court. An 8% risk adjustment factor to the cash flows is
considered appropriate to reflect the uncertainties in the cash flow estimates. The court is
expected to rule in late December 2015. The appropriate discount rate is 12%. The PV of 1
at 12% for one period is .89. What is the measurement of the provision on December 31,
2014?
A. 1,139,200 C. 1,280,000
B. 1,230,336 D. 1,382,400 FA 2 © 2014
40. During 2013, Libya Company is the defendant in a breach of patent lawsuit. The lawyers
believe there is an 80% chance that the court will not dismiss the case and the entity will incur
outflow of benefits. If the court rules in favor of the claimant, the lawyers believe that there is
a 60% chance that the entity will be required to pay damages of P2,000,000 and a 40%
chance that the entity will be required to pay damages of P1,000,000. Other amounts of
damages are unlikely. The court is expected to rule in late December 2014. There is no
indication that the claimant will settle out of court.
A 7% risk adjustment factor to the cash flows is considered appropriate to reflect the
uncertainties in the cash flow estimates. An appropriate discount rate is 10% per year. The
present value of 1 at 10% for one period is 0.91. What is the measurement of the provision
on December 31, 2013?
A. 1,246,336 C. 1,369,600
B. 1,280,000 D. 1,500,000 P1 © 2013
41. On November 5, 2014, a Dunn Company truck was in an accident with an auto driven by Bell.
The entity received notice on January 12, 2015 of a lawsuit for P700,000 damages for
personal injuries suffered by Bell. The entity's counsel believed it is probable that Bell will be
awarded an estimated amount in the range between P200,000 and P500,000. The possible
outcomes are equally likely. The accounting year ends on December 31 and the 2014
financial statements were issued on March 2, 2015.
What amount of provision should be accrued on December 31, 2014?
A. 0 C. 350,000
B. 200,000 D. 500,000 FA 2 © 2014
42. On November 5,2013, a Dunn Company truck was in an accident with an auto driven by Bell.
Dunn received notice on January 15, 2014 of a lawsuit for P700,000 damages for personal
injuries suffered by Bell. The entity's counsel believed it is probable that Bell will be awarded
an estimated amount in the range between P200,000 and P450,000, and no amount is a
better estimate of potential liability than any other amount because each point in the range is
as likely as any other. The 2013 financial statements were issued on March 1, 2014. What
amount of loss should be accrued on December 31,2013?
A. 0 C. 325,000
B. 200,000 D. 450,000 P1 © 2013
43. On November 25, 2014, an explosion occurred at a Rex Company plant causing extensive
property damage to area buildings. By March 10, 2015, claims had been asserted against
Rex Company. The management and counsel concluded that it is probable Rex Company
will be responsible for damages, and that P3,500,000 would be a reasonable estimate of its
liability. The entity's P10,000,000 comprehensive public liability policy has a P500,000
deductible clause.
What should be reported in the December 31, 2014 financial statements which were issued
on March 25, 2015?
A. An accrued liability of P500,000.
B. An accrued liability of P3,500,000.
C. A footnote disclosure indicating the probable loss of P3,500,000.
D. A footnote disclosure indicating the probable loss of P500,000. FA 2 © 2014
44. Nia Company is involved in litigation regarding a faulty product sold in a prior year. The entity
has consulted with an attorney and determined that it is possible that the entity may lose the
case. The attorney estimated that there is a 40% chance of losing. If this is the case, the
attorney estimated that the amount of any payment would be P5,000,000. What is the
required journal entry as a result of this litigation?
A. No journal entry is required. FA 2 © 2014
B. Debit litigation expense for P2,000,000 and credit litigation liability for P2,000,000.
C. Debit litigation expense for P3,000,000 and credit litigation liability for P3,000,000.
D. Debit litigation expense for P5,000,000 and credit litigation liability for P5,000,000.
45. Tone Company is the defendant in a lawsuit filed by Witt in 2013 disputing the validity of
copyright held by Tone. On December 31, 2013, Tone determined that Witt would probably
be successful for an estimated amount of P400,000. Appropriately, a P400,000 loss was
accrued by a charge to income for the year ended December 31, 2013.
On December 31, 2014, Tone and Witt agreed to a settlement providing for cash payment of
P250,000 by Tone to Witt, and transfer of Tone's copyright to Witt. The carrying amount of
the copyright on Tone's accounting records was P60,000 on December 31, 2014. What would
be the effect of the settlement on Tone's income before tax in 2014?
A. 150,000 increase C. 90,000 decrease
B. 60,000 decrease D. 90,000 increase FA 2 © 2014
46. Prime Company has long owned a manufacturing site that has now been discovered to be
contaminated with toxic waste. The entity has acknowledged its responsibility for the
contamination. An initial clean up feasibility study has shown that it will cost at least P500,000
to clean up the toxic waste. During the current year, the entity has been sued for patent
infringement and lost the case. A preliminary judgment of P300,000 was issued and is under
appeal. The entity's attorneys agree that it is probable that the entity will lose this appeal.
What amount of provision should be accrued as liability?
A. 0 C. 500,000
B. 300,000 D. 800,000 P1 © 2013
47. Eastern Company has several contingent liabilities on December 31,2013. The auditor
obtained the following brief description of each liability.
In May 2013, Eastern Company became involved in litigation. In December 2013, the
court assessed a judgment for P1,600,000 against Eastern. The entity is appealing the
amount of the judgment. The entity's attorneys believed it is probable that they can
reduce the assessment on appeal by 50%.
In July 2013, Pasig City brought action against Eastern Company for polluting the Pasig
River with its waste products. It is probable that Pasig City will be successful but the
amount of damages Eastern might have to pay should not exceed P1,500,000.
What total amount should be accrued as provision on December 31,2013?
A. 1,500,000 C. 2,300,000
B. 1,600,000 D. 3,100,000 P1 © 2013
Gain contingencies
48. During the current year, Haze Company won a litigation award for PI,500,000 which was
tripled to P4,500,000 to include punitive damages. The defendant, who is financially stable,
has appealed only the P3,000,000 punitive damages. The entity was awarded P5,000,000 in
an unrelated suit it filed, which is being appealed by the defendant. Counsel is unable to
estimate the outcome of these appeals.
In the income statement for the current year, what amount of pretax gain should be reported?
A. 1,500,000 C. 5,000,000
B. 4,500,000 D. 9,500,000 FA 2 © 2014
49. On January 1, 2014, Brenda Company owned a machine with cost of P2,000,000. The
accumulated depreciation was PI,200,000, estimated residual value was P120,000 and fair
value was P3,200,000. On January 3, 2014, this machine was irreparably damaged by Lann
Company and became worthless. In October 2014, a court awarded damages of P3,200,000
against Lann in favor of Brenda. On December 31, 2014, the final outcome of this case was
awaiting appeal and was therefore uncertain. However, in the opinion of Brenda's attorney,
Lann's appeal will be denied. On December 31, 2014, what amount of gain should be
accrued?
A. 0 C. 260,000
B. 200,000 D. 320,000 FA 2 © 2014
50. In May 2014, Caso Company filed suit against Wayne Company seeking PI,900,000
damages for patent infringement. A court verdict in November 2014 awarded Caso Company
PI,500,000 in damages, but Wayne Company's appeal is not expected to be decided before
2015.
The legal counsel believed it is probable that Caso Company will be successful against
Wayne Company for an estimated amount in the range between P800,000 and Pi, 100,000,
with PI,000,000 considered the most likely amount.
What amount should Caso Company record as income from the lawsuit for the year ended
December 31, 2014?
A. 0 C. 1,100,000
B. 1,000,000 D. 1,500,000 FA 2 © 2014
51. During 2014, Smith Company filed suit against West Company seeking damages for patent
infringement. On December 31, 2014, the legal counsel believed that it was probable that
Smith Company would be successful against West Company for an estimated amount of
PI,500,000. In March 2015, Smith Company was awarded PI,000,000 and received full
payment thereof.
In Smith Company's 2014 financial statements issued February 2015, how should this award
be reported?
A. As a receivable and revenue of P1,000,000.
B. As a disclosure of a contingent asset of P1,500,000.
C. As a disclosure of a contingent asset of P1,000,000.
D. As a receivable and deferred revenue of P1,000,000. FA 2 © 2014
54. Ginger Company is completing the preparation of the draft financial statements for the year
ended December 31, 2014. The financial statements are authorized for issue on March
31,2015.
On March 15, 2015, a dividend of P1,750,000 was declared and a contractual profit share
payment of P350,000 was made, both based on the profit for the year ended December 31,
2014. On February 1, 2015, a customer went into liquidation having owed the entity P340,000
for the past 5 months. No allowance had been made against this debt in the draft financial
statements. On March 20, 2015, a manufacturing plant was destroyed by fire resulting in a
financial loss of P2,600,000. What total amount should be recognized in profit or loss for the
year ended December 31, 2014 to reflect adjusting events after the end of reporting period?
A. 690,000 C. 2,600,000
B. 1,750,000 D. 3,290,000 FA 2 © 2014
55. Elysee Company reported in the draft financial statements for the year ended December 31,
2014 profit before tax of P9,000,000. The board of directors authorized the financial
statements for issue on March 20, 2015.
A fire occurred at one of Elysee's sites on January 15, 2015 with resulting damage costing
P7,000,000, only P4,000,000 of which is covered by insurance. The repairs will take place
and be paid for in April 2015. The P4,000,000 claim from the insurance entity will however
be received on February 14, 2015. What amount should be reported as profit before tax for
2014?
A. 2,000,000 C. 9,000,000
B. 6,000,000 D. 13,000,000 FA 2 © 2014
56. During 2014 Beal Company became involved in a tax dispute with the BIR. On December
31, 2014, the entity's tax advisor believed that an unfavorable outcome was probable and the
best estimate of additional tax was P500,000, but could be as much as P650,000. After the
2014 financial statements were issued, the entity received and accepted a BIR settlement
offer of P550,000. What amount of accrued liability should be reported on December 31,
2014?
A. 0 C. 550,000
B. 500,000 D. 650,000 FA 2 © 2014
Noncurrent liabilities
57. Jam Company had P5,000,000 note payable that is due on March 1, 2015. The entity
borrowed P3,500,000 on February 1, 2015 which has a five-year term and used the proceeds
to pay down the note and used other cash to pay the balance. The 2014 financial statements
were issued on March 31, 2015. What amount of the note payable should be classified as
noncurrent on December 31, 2014?
A. 0 C. 3,500,000
B. 1,500,000 D. 5,000,000 FA 2 © 2014
58. Dana Company had P2,000,000 note payable due on June 30, 2015. Under the existing loan
facility, the entity had the discretion to refinance or roll over the note payable for at least
twelve months after the end of reporting period. On December 31, 2014, what amount of the
note payable should be reported as noncurrent liability?
A. 0 C. 2,400,000
B. 2,000,000 D. 3,000,000 FA 2 © 2014
Total liabilities
59. Ducky Company reported the following information on December 31, 2014:
Accounts payable 1,000,000
Advances to employees 45,000
Unearned rent revenue 300.000
Estimated liability under warranties 250,000
Cash surrender value of officers' life insurance 75,000
Bonds payable 5,000,000
Discount on bonds payable 500,000
Trademark 50,000
What amount should be reported in the statement of financial position as total liabilities?
A. 1,550,000 C. 6,095,000
B. 6,050,000 D. 7,050,000 FA 2 © 2014
Straight Problems
Premium & coupon
60. Miracle Company manufacturers a product that is packaged and sold. A plate is offered to
customers sending in three wrappers accompanied by a remittance of P10. Data with respect
to the premium offer are summarized below.
2014 2015
Sales 3,600,000 4,200,000
Purchase of premium (P50 per plate) 390,000 580,000
Number of plates distributed as premiums 5,000 9,000
Estimated number of plates to be
distributed in subsequent period 2,000 3,000
Distribution cost P20 per plate
Required:
Prepare journal entries that would be made in 2014 and 2015 to record sales, premium
purchases and redemptions, and year-end adjustments.
61. Pop Company sells banana juice. In order to promote the drink among teenagers and others
who might otherwise be indifferent to the product, the entity inaugurated in the current year
a premium plan called "Drink-N-Win." For every 10 bottle caps and P5 turned in, customers
receive an attractive ball-pen and become eligible for a grand prize of P5,000 in cash which
is awarded for every 100 tops turned in. The entity estimated that only 25% of bottle caps
reaching the hands of customers will be presented for redemption.
During the current year, the entity sold 400,000 bottles of banana juice at P9 each, purchased
10,000 ball point pens for a total cost of P900,000, and incurred nondeferrable costs of
P30,000 applicable to the premium plan. A total of 8,000 pens have been redeemed and
thirty grand prizes have been awarded. At the end of the year, the entity recognized an
estimated liability equal to the estimated cost of prizes outstanding.
Required:
Prepare journal entries to record the transactions relating to the premium plan for the current
year.
62. Cascade Company manufactures a special laundry soap. A towel is offered as a premium to
customers who send in two proof-of-purchase seals from the soap boxes and a remittance
of P20. Distribution cost is P5 per towel. Data for the premium offer are.
2014 2015
Soap sales 2,500,000 3,125,000
Towel purchases (P100 per towel) 175,000 200,000
Number of towels distributed as premium 1,000 1,800
Number of towels expected to be
distributed in subsequent period 600 800
Required:
During 2014, the entity issued 50,000 award credits and expects that 80% of these award
credits shall be redeemed. The fair value of the of the award credits is reliably measured at
P2,000,000. In 2014, the entity sold goods to customers for a total consideration of
P9,000,000 including the fair value of the award credits.
The award credits redeemed and the total award credits expected to be redeemed each year
are as follows:
Redeemed Expected to be redeemed
2014 15,000 80%
2015 7,950 85%
2016 2,550 85%
2017 15,000 90%
Required
64. Susan Company participates in a customer loyalty program operated by an airline in which
customers earn air travel points when they purchase goods from the entity. The air travel
points can be redeemed for free air travel. The entity pays the airline P50 per air travel point
and considers that the fair value of the air travel point is P60. During the current year, the
entity sold goods for P5,000,000 and granted 5,000 points.
Required
Prepare journal entries for the current year assuming the entity is the principal in the
transaction and the entity is an agent of the airline.
Product warranty
65. Socorro Company sells color television sets with a two-year repair warranty. The sale price
for each set is P15,000. The average repair cost per set is P800. Research has shown that
20% of all sets sold are repaired in the first year and 40% in the second year. The number of
sets sold were as follows: 300 in 2014, 500 in 2015. Total payments for repairs associated
with the warranties were P40,000 in 2014, P150,000in2015.
Required:
1. Prepare journal entries in connection with the warranty using the "expense as incurred"
approach.
2. Prepare journal entries in connection with the warranty using the "accrual" approach.
3. Determine the estimated warranty liability on December 31,2015.
4. Analyze the estimated warranty liability account to ascertain whether actual warranty
costs approximate the estimate. The sales and warranty repairs are made evenly during
the year.
5. Prepare journal entry to correct the estimated warranty liability on December 31, 2015.
66. In 2014, Dare Company began selling a new calculator that carried a two-year warranty
against defects.
Dare projected the estimated warranty cost (as a percent of sales) as follows:
First year of warranty 4%
Second year of warranty 10%
Required:
1. Prepare journal entries in connection with the warranty using the "expense as incurred"
approach.
2. Prepare journal entries in connection with the warranty using the "accrual" approach.
3. Determine the estimated warranty liability on December 31,2015.
4. Analyze the estimated warranty liability account to ascertain if adjustment is necessary.
The sales and warranty repairs are made evenly during the year.
5. Prepare the adjustment to correct the estimated warranty liability on December 31, 2015.
67. In 2014, Plumpton Company started selling new computer that carried a 2-year warranty
against defects. Based on the manufacturer's recommendations, the entity estimated
warranty cost as a percentage of sales as follows:
First year of warranty 3%
Second year of warranty 9%
Required:
1. Prepare journal entries to record the transactions for 2014 and 2015.
2. Analyze the estimated warranty liability account on December 31, 2015 to ascertain if
the actual repairs approximate the estimate. The sales and repairs occur evenly
throughout the year.
3. Prepare the adjustment of the estimated warranty liability on December 31, 2015.
68. Sony Company sells stereos under a 2-year warranty contract that requires the entity to
replace defective parts and provide free labor on all repairs.
During 2013, 1,000 units were sold at P9,000 each. In 2014, the entity sold an additional 900
units at P9,250 each. Sales occurred on the last day of the year for both 2013 and 2014.
Based on past experience, the estimated 2-year warranty costs are P200 for parts and P250
for labor per unit. It is also estimated that 40% of the warranty expenditures will occur in the
first year and 60% in the second year. Actual warranty expenditures were as follows:
2014 2015
Stereos sold in 2013 180,000 280,000
Stereos sold in 2014 190,000
Required:
69. Dawson Company manufactures television components and sells them with a 6-month
warranty under which defective components will be replaced without charge. On January 1,
2014, the warranty liability had a balance of P620,000. By June 30, 2014, this balance had
been reduced to Pl20,400 by debits for estimated net cost of components returned that had
been sold in 2013.
The entity started out in 2014 expecting 7% of sales to be returned. However, due to the
introduction of new models during the year, this estimated percentage of returns was
increased to 10% on May 1. It is assumed that no components sold during a given month are
returned in that month. Each component is stamped with a date at time of sale so that the
warranty may be properly administered.
The following table of percentages indicates the likely pattern of sales returns during the 6-
month period of the warranty, starting with the month following the sale of components.
Percentage of total
Month following sale returns expected
First 30%
Second 20
Third 20
Fourth through sixth - 10% each month 30
100%
Gross sales of components were as follows for the first six months of 2014:
Month Amount Month Amount
January 4,200,000 April 3,250,000
February 4,700,000 May 2,400,000
March 3,900,000 June 1,900,000
The warranty also covers the payment of freight cost on defective components returned and
on the new components sent out as replacements. This freight cost runs approximately 5%
of the sales price of the components returned.
The manufacturing cost of the components is roughly 70% of sales price, and the salvage
value of returned components averages 10% of their sales price.
Returned components on hand on January 1, 2014, were thus valued in inventory at 10% of
their original sales price.
Required:
70. Precise Company sells an electric timer that carries a 90-day unconditional warranty against
product failure. Based on a reliable statistical analysis, 2% of units sold will require an
average cost of P150 per unit.
Required:
Prepare a journal entry to record the estimated liability for warranty on December 31. The
warranty costs of known failures have already been reflected in the records.
71. Anneliese Company sells televisions at an average price of P9,000 and also offers a separate
three-year warranty contract for P900 that requires the entity to perform periodic services and
replace defective parts. During 2014, the entity sold 300 television sets and 270 extended
warranty contracts for cash. The entity estimated the three-year warranty cost as P200 for
parts and P400 for labor and accounts for the sale of warranty separately.
The sale occurred on December 31, 2014. The entity recognizes income from the sale of
warranty on a straight line basis. In 2015, the entity incurred actual cost relative to the
warranty of P20,000 for parts and P40,000 for labor.
Required:
1. Prepare journal entries in 2014 and 2015.
2. How is the unearned revenue from warranty contracts presented on December 31,
2015?
Environmental provision
72. Prime Company provided the following information for the current year:
Prime Company has long owned a manufacturing site that has now been discovered to
be contaminated with toxic waste. The entity has acknowledged its responsibility for the
contamination. An initial clean up feasibility study has shown that it will cost at least
P500,000 to clean up the toxic waste.
Prime Company has been sued for patent infringement and lost the case. A preliminary
judgment of P300,000 was issued and is under appeal. The entity's attorneys agree that
it is probable that the entity will lose this appeal.
Required:
Prepare journal entries to recognize any provision at the end of current year.
Restructuring provision
73. Troy Company decided on November 1, 2014 to restructure the entity's operations.
* Mindanao Branch would be closed down to concentrate on Manila operations.
* 200 employees working in Mindanao Branch would be retrenched on November 30,
2014, and would be paid their accumulated entitlements plus three months' wages.
* The remaining 50 employees working in Mindanao Branch would be transferred to
Manila, which would continue operating.
* Five executives would be retrenched on December 31, 2014, and would be paid their
accumulated entitlements plus three months' wages.
On December 31, 2014, the following transactions and events had occurred:
* Mindanao Branch was shut down on November 30, 2014.
* The 200 retrenched employees have left and their accumulated entitlements have been
paid. However, an amount of PI,500,000, representing a portion of the three months'
wages for the retrenched employees, has still not been paid.
* Costs of P400,000 were expected to be incurred in transferring the 50 employees to their
new work in Manila. The transfer is planned for January 15, 2015.
* Four of the five executives who have been retrenched have had their accumulated
entitlements paid, including the three months' wages. However, one remains in order to
complete administrative tasks relating to the closure of Mindanao Branch and the
transfer of staff to Manila. This executive is expected to stay until January 31, 2015. His
salary for January will be P50,000 and his retrenchment package will be P200,000, all
of which will be paid on the day he leaves. He estimates that he would spend 60% of his
time administering the closure of Mindanao Branch, 30% on administering the transfer
of staff to Manila, and the remaining 10% on general administration.
Required:
74. Anneliese Company is involved in a restructuring related to its toy division. The controller and
chief finance officer are considering the following costs to accrue as part of the restructuring.
The entity has a long-term lease on one of the facilities related to the division. It is estimated
that it will have to pay a penalty of P4,000,000 to break the lease. The entity estimates that
the present value related to payment on the lease contract is P6,500,000.
The entity's allocation of overhead costs to other divisions will increase by P15,000,000 due
to the restructuring of the facilities.
Also, some employees will be shifted to other divisions within the entity and cost of retraining
the employees is estimated atP20,000,000.
The entity has hired an outplacement firm to help in dealing with the number of terminations
related to the restructuring. It is estimated that the cost to the entity will be P6,000,000.
Employee termination costs are estimated to be P30,000,000 and the entity believes that
moving usable assets from the toy division to other division within the entity will cost
P3,200,000.
Required:
Compute the total amount that should be included in restructuring provision. '
Decommissioning provision
75. On January 1, 2014, Petron Company purchased on oil tanker depot at a cost of P6,000,000.
The entity is expected to operate the depot for 5 years after which it is legally required to
dismantle the depot and remove the underground storage tanks. The oil tanker depot is
depreciated using straight line with no residual value.
It is reliably estimated that the cost of decommissioning the depot will amount to PI,500,000.
The appropriate discount rate is 10%. The present value of 1 at 10% for 5
periods is 0.62.
On December 31, 2018, after 5 years of operating the depot, the entity paid a demolition
entity to dismantle the depot at a price of Pl,700,000.
Required:
1. Prepare journal entries in 2014 in relation to the depot and the decommissioning liability.
2. Prepare journal entries to record the derecognition of the depot and the settlement of the
decommissioning liability on December 31, 2018.
76. On January 1, 2014, Stanford Company purchased a mining site that will have to be restored
to certain specifications when the mining production ceases. The cost of the mining site is
P8,000,000 and the restoration cost is expected to be P2,000,000. It is estimated that the
mine will continue in operation for 10 years.
The appropriate discount rate is 8%. The present value of 1 at 8% for 10 periods is 0.4632.
On December 31, 2023, the entity contracted with another entity for the restoration of the
mining site in accordance with specifications at a cost of Pl,800,000.
Required:
1. Prepare journal entries in 2014 to record the purchase of the mining site and the
recognition of the decommissioning liability.
2. Prepare journal entry to record the settlement of the decommissioning liability on
December 31, 2023.
77. On January 1, 2014, Camille Company purchased a gas detoxification facility for P9,000,000.
The cost of cleaning up the routine contamination caused by the initial location of gas on the
property is estimated to be PI,500,000. This cost will be incurred in 10 years when all of the
existing stockpile of gas is detoxified and the facility is decommissioned.
Additional contamination may occur in succeeding years that the facility is in operation. On
January 1, 2016, additional contamination clean up cost is estimated at P200,000. The
appropriate discount rate is 6%. The present value of 1 at 6% is 0.63 for 8 periods and 0.56
for 10 periods.
On December 31, 2023, the entity paid a contractor an amount of P2,000,000 for the
decommissioning of the detoxification facility.
Required:
1. Prepare journal entries in 2014 in relation to the detoxification facility and the
decommissioning liability.
2. Prepare journal entries in 2016 in relation to the detoxification facility and
decommissioning liability.
3. Prepare journal entries on December 31, 2023 to record the derecognition of the
detoxification facility and the settlement of the decommissioning liability.
Lawsuits
78. Sunrise Company has several contingent liabilities on December 31, 2014. A brief description
of each liability is as follows:
A personal injury liability suit for P500,000 was brought against Sunrise Company in
March2014. The management and legal counsel of Sunrise Company concluded that it
is not probable that Sunrise Company will be responsible for damages and that P150,000
is the best estimate of the damages.
In July 2014, Sunrise Company became involved in a tax dispute with the BIR pertaining
to 2013 income tax. In December 2014, a judgment for P400,000 was assessed against
Sunrise Company by the tax court. Sunrise Company is appealing the amount of the
judgment. The tax advisor and legal counsel of Sunrise Company believed it is probable
that the assessment can be reduced on appeal by 50%.
Sunrise Company signed as guarantor for P200,000 loan by PNB to Sunset Company,
a principal supplier of Sunrise. By reason of financial difficulties, it is probable that
Sunrise Company shall pay the P200,000 loan with only a 60% recovery anticipated from
Sunset Company.
Required:
79. A Singapore-based shipping entity lost an entire shipload of cargo valued at P5,000,000 on
a voyage to Australia. It is however covered by an insurance policy. According to the report
of the investigator, the amount is collectible, subject to the deductible clause in the insurance
policy.
Before year-end, the shipping entity received a letter from the insurance entity that a check
was in the mail for 90% of the claim.
The international freight forwarding entity that entrusted the shipping entity with the delivery
of the cargo overseas has filed a lawsuit for P5,000,000 claiming the value of the cargo that
was lost on high seas, and also consequential damages of P2,000,000 resulting from the
delay.
According to the legal counsel for the shipping entity, it is probable that the shipping entity
would have to pay the P5,000,000, but it is a remote possibility that it would have to pay the
additional P2,000,000 claimed by the international freight forwarding entity, since this loss
was specifically excluded in the freight forwarding contract.
Required:
Required:
Prepare journal entries to record the transactions and events. If you believe that no entry is
required, explain your answer.
Required:
Miscellaneous
82. Iriga Company issued the 2014 financial statements on March 1, 2015. The entity provided
the following data for the year ended December 31, 2014:
Amount owing to another entity for services rendered during December 2014 300,000
Estimated long service leave owing to employees in respect of past services 1,200,000
Estimated cost of relocating an employee from head office to a
branch in another city (employee will physically relocate January 2015) 100,000
Estimated cost of overhauling machine every 5 years (the machine is
5 years old on December 31, 2014) 150,000
Required:
83. The audit of Anne Company for the year ended December 31, 2014 was completed on March
1, 2015.
The financial statements were signed by the managing director on March 15, 2015 and
approved by the shareholders on March 31, 2015. The next events have occurred.
* On January 15, 2015, a customer owing P900,000 to Anne Company filed for
bankruptcy. The financial statements include an allowance for doubtful accounts
pertaining to this customer only of P100,000.
* Specialized equipment costing P525,000 purchased on September 1, 2014 was
destroyed by fire on December 15, 2014. Anne Company has booked a receivable of
P400,000 from the insurance entity. After the insurance entity completed the
investigation on February 1, 2015, it was discovered that the fire took place due to
negligence of the machine operator. As a result, the insurer's liability was zero on this
claim.
Required:
Prepare adjusting entries on December 31, 2014 to recognize the events after reporting
period.
84. Norway Company prepared the financial statements on December 31, 2014 and the financial
statements are authorized for issue on March 15, 2015.
* Norway Company had reported a contingent liability on December 31, 2014 related to a
court case in which Norway Company was the defendant. The case was not heard until
the first week of February 2015.
On February 11, 2015, the judge handed down a decision against Norway Company.
The judge determined that Norway Company was liable to pay damages and costs
totaling P3,000,000.
* On December 31, 2014, Norway Company had a receivable from a large customer in
the amount of P3,500,000.
On January 31, 2015, Norway Company was advised by the liquidator of the said
customer that the customer was insolvent and would be unable to repay the full amount
owed to Norway Company.
The liquidator advised Norway Company in writing that only 10% of the receivable will
be paid on April 30, 2015.
Required:
Prepare adjusting entries on December 31, 2014 to record the events after the reporting
period.
ANSWER EXPLANATION
1. Answer is (A).
Long term service leave = 1,200,000
A provision is a present obligation that is uncertain in amount or timing. The present obligation
must be both probable and measurable.
The amount owing to another entity is a present obligation but technically it is not a provision
because the amount is certain. Of course, it is an accrued liability.
The estimated cost of relocating the employee is a future cost because it is to be incurred in
January 2014. Thus, it is not included in December 31,2013 provision.
The estimated cost of overhaul is not a provision because there is no present obligation. The
entity may decide to sell the machine or not to repair it.
2. Answer is (B).
Premiums distributed in 2015 5,500
Estimated premiums in 2015 500
Total 6,000
Less: Estimated premiums in 2014 200
Premiums applicable to 2015 5,800
Premium expense (5,800 x 60) 348,000
3. Answer is (A).
Premium distributed in 2015 50,000
Premiums to be distributed in 2016 3,000
Total 53,000
Premiums arising from 2014 sales distributed in 2015 (5,000)
Premiums applicable to 2015 48,000
Premium expense (48,000 x 40) 1,920,000
4. Answer is (B).
Coupons to be redeemed (160,000 x 60%) 96,000
Less: coupons redeemed 40,000
Balance 56,000
Number of premiums (56,000 / 5) 11,200
Amount of liability (11,200 x 20) 224,000
5. Answer is (C).
Premiums to be distributed (250,000 x 80% / 10) 20,000
Premiums distributed 15,000
Balance 5,000
Premium liability (5,000 x 100) 500,000
6. Answer is (B).
Boxtops to be redeemed (675,000 x 60%) 405,000
Boxtops redeemed (330,000)
Boxtops outstanding 75,000
Estimated liability – December 31, 2014 (75,000 / 3 x 15) 375,000
7. Answer is (A).
Beermugs to be distributed (50% x 300,000 / 20) 7,500
Beermugs already distributed 4,500
Beermugs outstanding 3,000
Estimated liability – December 31, 2014 (45 x 3,000) 135,000
8. Answer is (A).
Basketballs to be distributed (100,000 x 60% / 10) 6,000
Basketballs distributed 4,000
Balance 2,000
Multiply by cost of basketball (4,125,000 / 5,500) 750
Estimated liability 1,500,000
9. Answer is (C).
Coupons to be redeemed in 2014 and 2015 (1,300,000 x 30%) 390,000
Coupons redeemed in 2014 & 2015 (140,000 + 200,000) 340,000
Outstanding coupons – 12/31/2015 50,000
Divide by 10
Number of towels 5,000
Multiply by cost of towels minus remittance (100 – 20) 80
Estimated liability – 12/31/2015 400,000
Weighted probabilities:
5% x 400,000 20,000
20% x 200,000 40,000
50% x 80,000 40,000
25% x 20,000 5,000
Expected cash flows 105,000
31. Answer is (A). The guarantee should be accrued as a provision because the loss is probable
and the amount can be reasonably estimated.
33. Answer is (A). The loss is accrued as a provision because it is probable and they amount
can be reasonably estimated.
34. Answer is (C). The loss on the first lawsuit is both probable and measurable and therefore
can be accrued as a provision.
35. Answer is (C). Accrue the most probable cost of P3,600,000 and disclose the additional
contingency of 2,400,000 (6,000,000 – 3,600,000).
36. Answer is (D). The probable loss is recorded but the possible loss is only disclosed.
37. Answer is (C).
Estimated liability for lawsuit 5,000,000
The lawsuit claim of P5,000,000 is recognized as a provision because it is both probable and
measurable. However, the additional claim of P2,000,000 is not recognized because it is
remote.
41. Answer is (C). The provision should be accrued because it is probable and measurable. The
accrued amount is P350,000 which is the midpoint of the range in the absence of the best
estimate within the range.
43. Answer is (A). The loss is accrued as a provision because it is probable and measurable.
The accrued amount is P500,000 only because it is the extent of liability of Rex under the
comprehensive insurance policy.
48. Answer is (A). Haze can report a gain of P1,500,000 in its 2014 income statement because
this amount is already settled on December 31, 2014. However, the remainder of P3,000,000
is only disclosed because the defendant has appealed the said amount.
49. Answer is (A). Final outcome of the case was awaiting appeal and still uncertain.
50. Answer is (A). Contingent assets are not recognized in financial statements since this may
result in the recognition of income that may never be realized. A contingent asset and the
related contingent gain are disclosed only where the inflow of economic benefits is probable.
51. Answer is (B). The contingent asset is disclosed only because the case is unresolved on
December 31, 2014. The issue is what amount of asset will be disclosed. Since the case is
settled in March 2015 after the issuance of the 2014 financial statements, the amount of
P1,500,000 should be disclosed. However, if the case is settled before the issuance of the
statements, the actual award of P1,000,000 should be disclosed.
53. Answer is (C). The decision of the Supreme Court made on February 15, 2015 which is
before the issuance of the statements on February 20, 2015. Accordingly, the accrued
provision should be equal to the amount of P3,500,000 decided by the Supreme Court. The
date of issue of financial statements is the date when the board of directors approved the
financial statements.
55. Answer is (C). The profit remains at P9,000,000. The fire occurring on January 5, 2015 is a
non-adjusting event on December 31, 2014.
56. Answer is (B). The best estimate is recorded. The accepted BIR offer is not recorded
because it was made after the statements are issued.
58. Answer is (B). The entire amount of the note payable is classified as noncurrent liability.
PAS 1, paragraph 73, provides that if an entity has the discretion to refinance or roll over an
obligation for at least twelve months after the end of the reporting period, it shall classify the
obligation as noncurrent, even if it would otherwise be due within a shorter period.
Premiums 390,000
Cash 390,000
Cash 4,200,000
Sales 4,200,000
Premiums 580,000
Cash 580,000
Premiums 900,000
Cash 900,000
Premiums 150,000
Cash 150,000
62. Requirement 1:
2014 1. Cash 2,500,000
Sales 2,500,000
Cash 3,125,000
Sales 3,125,000
2. “Accrual” approach
2014 Cash (300 x 15,000) 4,500,000
Sales 4,500,000
2015 First contract year of 7/1/2014 sales (150 x 20% x 800 x 6/12) 12,000
Second contract year of 1/1/2014 sales (150 x 40% x 800) 48,000
Second contract year of 7/1/2014 sales (150 x 40% x 800 x 6/12) 24,000
2016 Second contract year of 7/1/2014 sales (150 x 40% x 800 x 6/12) 24,000
Warranty expense 144,000
2016 First contract year of 7/1/2015 sales (250 20% x 800 x 6/12) 20,000
Second contract year of 1/1/2015 sales (250 x 40% x 800) 80,000
Second contract year of 7/1/2015 sales (250 x 40% x 800 x 6/12) 40,000
2017 Second contract year of 7/1/2015 sales (250 x 40% x 800 x 6/12) 40,000
Warranty expense 240,000
5.
2014 sales still under warranty after 12/31/2015:
Second contract year of 7/1/2014 sales 24,000
2015 sales still under warranty after 12/31/2015:
First contract year of 7/1/2015 sales 20,000
Second contract year of 1/1/2015 sales 80,000
Second contract year of 7/1/2015 sales (40,000 + 40,000) 80,000
Estimated warranty liability – 12/31/2015 204,000
Estimated warranty liability per book 194,000
Increase in warranty liability 10,000
Requirement 2:
2014 1. Cash 5,000,000
Sales 5,000,000
Requirement 3:
Warranty expense
2014 700,000
2015 1,260,000 1,960,000
Actual warranty repairs
2014 200,000
2015 560,000 760,000
Estimated warranty liability, 12/31/20115 1,200,000
67. Requirement 1:
2014 1. Cash 5,000,000
Sales 5,000,000
Requirement 2:
Warranty expense for 2014 & 2015 (600,000 + 840,000) 1,440,000
Actual warranty repairs (100,000 + 250,000) 350,000
Estimated warranty liability – 12/31/2015 1,090,000
68. Requirement 1:
2013 1. Cash 9,000,000
Sales 9,000,000
69. Requirement 1:
Total Returns after
Sales Percent Returns 6/30/2014 Amount
January 4,200,000 7% 294,000 10% 29,400
February 4,700,000 7% 329,000 20% 65,800
March 3,900,000 7% 273,000 30% 81,900
April 3,250,000 7% 227,500 50% 113,750
May 2,400,000 10% 240,000 70% 168,000
June 1,900,000 10% 190,000 100% 190,000
640,850
Total returns as of
Sales Jan Feb Mar Apr May June 6/30/2014
January - 30% 20% 20% 10% 10% 90%
February - - 30% 20% 20% 10% 80%
March - - - 30% 20% 20% 70%
April - - - - 30% 20% 50%
May - - - - - 30% 30%
June - - - - - - -
Requirement 2:
Manufacturing cost 70%
Freight 5%
Total 75%
Salvage value (10%)
Net loss on component returned 65%
Requirement 3:
Warranty expense 301,353
Estimated warranty liability 301,353
Units sold:
October 32,000
November 28,000
December 40,000
Total 100,000
Multiply by: 2%
Total failures expected 2,000
Less: Failures already recorded:
October sales 640
November sales 360
December sales 180 1,180
Expected future failures 820
Multiply by 150
Estimated cost 123,000
71. Requirement 1:
2014 Cash 2,943,000
Sales 2,700,000
Unearned warranty revenue 243,000
75. Requirement 1
2014
Jan 1 Oil tanker depot 6,000,000
Cash 6,000,000
1 Oil tanker depot 930,000
Decommissioning liability (1,500,000 x 0.62) 930,000
Dec. 31 Depreciation 1,386,000
Accum. depreciation (6,930,000/5) 1,386,000
31 Interest expense 93,000
Decommissioning liability (10% x 930,000) 93,000
Requirement 2
2018
Dec. 31 Accum. depreciation 6,930,000
Oil tanker depot 6,930,000
31 Decommissioning liability 1,500,000
Loss on settlement of decommissioning liability 200,000
Cash 1,700,000
76. Requirement 1
2014
Jan. 1 Mining site 8,000,000
Cash 8,000,000
1 Mining site 926,400
Decommissioning liability (2,000,000 x .4632) 926,400
Requirement 2
2023
Dec. 31 Decommissioning liability 2,000,000
Cash 1,800,000
Gain on settlement of decommissioning liability 200,000
Requirement 2 (2016)
Jan. 1 Detoxification facility 126,000
Decommissioning liability (200,000 x .63) 126,000
Dec. 31 Depreciation 999,750
Accumulated depreciation (9,840,000 / 10)) 999,750
78. 1. Only a disclosure is necessary because it is not probable that the company will be liable,
although the amount can be measured reliably.
2. Retained earnings 200,000
Estimated liability for income tax 200,000
3. Accounts receivable – Sunset 120,000
Loss on guaranty 80,000
Note payable – bank 200,000
79. The shipping company shall recognize a provision for P5,000,000 because the claim on the
international freight forwarding company is probable. No provision or disclosure would be
needed for the P2,000,000 claim of the international freight forwarding company because
there is a remote possibility for the payment. The shipping company shall also recognize a
contingent asset of P4,500,000 (90% x P5,000,000), because the amount is virtually certain
of collection.