Chapter 9 - Audit of Liabilities Roque

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Share this document IX – AUDIT OF LIABILITIES

PROBLEM NO. 1 – Current and noncurrent liabilities

You were able to obtain the following from the accountant for Agdangan Corp. related to the company’s
Facebook liabilities as of December 31, 2010. Twitter
Accounts Payable P 650,000

#
Notes Payable – trade 190,000
Notes Payable – bank 800,000
Wages and salaries payable 15,000
Interest payable ?
Email Mortgage notes
Mortgage notes payable
payable –
– 12%
10% 600,000
1,500,000
Bonds Payable 2,000,000

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The following additional information pertains to these liabilities.

a. All trade notes payable are due within six months from the end of the reporting period.
b. Bank notes-payable include two separate notes payable to Allied Bank.
(1) A P300,000, 8% note issued March 1, 2008, payable on demand. Interest is payable every six-

$ months.
%
(2) A 1-year, P500,000, 11 ½ % not issued January 2, 2010. On December 30, 2010, Agdangan
negotiated a written agreement with Allied Bank to replace the note with a 2-year, P500,000,
10% note to be issued January 2,2011. The interest was paid on December 31, 2010.
c. The 10% mortgage note was issued October 1, 2007, with a term of 10 years. Terms of the note
give the holder the right to demand immediate payment if the company fails to make a monthly
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interest payment within 10 days of the date the payment is due. As of December 31, 2016,
Agdangan is three months behind in paying its required interest payment.
d. The 12% mortgage note was issued May 1,2004, with a term of 20 years. The current principal
amount due is P1,500,000. Principal and interest payable annually on April 30. A payment of
P220,000 is due April 30, 2011. The payment includes interest of P180,000.
e. The bonds payable is 10-year, 8% bonds, issued June 30, 2001. Interest is payable semi-annually
every June 30 and December 31.

QUESTIONS:

Based on the above and the result of your audit, answer the following.

1. Interest payable as of December 31, 2010 is

a. P155,000 c. P143,000
b. P203,000 d. P215,000
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2. The portion of the Note Payable-bank to be reported under current liabilities as of December 31,
2010 is
a. P300,000 c. P500,000
b. P800,000 d. P 0

3. Total current liabilities as of December 31, 2010 is

a. P3,950,000 c. P4,138,000
b. P3,938,000 d. P 0

4. Total noncurrent liabilities as of December 31, 2010 is

a. P1,760,000 c. P2,560,000
b. P3,960,000 d. P1,960,000

Answers: 1)C 2)A 3)B 4)D

Suggested Solution:

Question No. 1

P300,000 note payable to bank (P300,000 x 8% x 4/12) P 8,000

Mortgage note payable – 10% (P600,000 x 10% x 3/12) 15,000
Mortgage note payable – 12% (P1,500,000 x 12% x 8/12) 120,000
Total interest payable, 12/31/10 143,000

Question No. 2

Note payable to bank – payable on demand P 300,000

The P500,000 note payable to bank will be classified as noncurrent because it was refinanced on a long
term basis as of December 31, 2010.

Question No. 3

Accounts Payable P 650,000

Notes Payable – trade 190,000
Notes Payable – bank (see no. 2) 300,000

Wages and salaries payable 15,000

Interest payable (see no. 1) 143,000
Mortgage note payable – 10% (with breach of loan covenant) 600,000
Mortgage note payable – 12% (P220,000 – P180,000) 40,000
Bonds payable, due 7/1/11 2,000,000
Total current liabilities, 12/31/10 P3,938,000
In accordance with the revised PAS 1 par. 69, an entity shall classify a liability as current when:

(a) it expects to settle the liability in its normal operating cycle;

(b) it holds the liability primarily for the purpose of trading;
(c) the liability is due to be settled within twelve months after the reporting period; or
(d) the entity does not have an unconditional right to defer settlement of the liability for at least
twelve months after the reporting period.

An entity shall classify all other liabilities as non-current.

When an entity breaches an undertaking under a long-term loan agreement on or before the end of the
reporting period with the effect that the liability becomes payable on demand, the liability is classified as
current, even if the lender has agreed, after the reporting period and before the authorization of the
financial statements for issue, not to demand payment as a consequence of the breach. The liability is
current, because at the end of the reporting period, the entity does not have an unconditional right to defer
its settlement for at least twelve months after that date. (PAS 1 par. 74)

However, the liability is classifies as non-current if the lender agreed by the end of the reporting period to
provide a period of grace ending at least 12 months after the reporting period, within which the entity can
rectify the breach and during which the lender cannot demand immediate repayment. [PAS 1 par. 75]

Question No. 4

Notes payable – bank (see no. 2) P 500,000

Mortgage note payable – 12% (P1,500,000 – P40,000) 1,460,000
Total noncurrent liabilities, 12/31/10 P 1,960,000

PROBLEM NO. 2 – Current and noncurrent liabilities

Atimonan Corporation is selling audio and video appliances. The company’s fiscal year ends on March 31.
The following information relates to the obligations of the company as of March 31, 2010:

Notes Payable

Atimonan has signed several long-term notes with financial institutions. The maturities of these notes are
given below. The total unpaid interest for all of these notes amounts to P408,000 on March 31, 2010.

Due date Amount

April 31, 2010 P 720,000
July 31, 2010 1,080,000
September 1, 2010 540,000
February 1, 2011 540,000
April 1, 2011 – March 31, 2012 3,240,000
P 6,120,000

Estimated warranties

Atimonan has a one-year product warranty on some selected items. The estimated warranty liability in sales
made during the 2008-2009 fiscal year and still outstanding as of March 31, 2009, amounted to P302, 400.
The warranty costs on sales made from April 1, 2009 to March 31, 2010, are estimated at P756,0 00. The

actual warranty costs incurred during 2009-2010 fiscal year are as follows:

Warranty claims honored on 2008-2009 sales P 302,400

Warranty claims honored on 2009-2010 sales 342,000
Total P 644,400

Trade payables
Trade payables

Accounts payable for supplies, goods, and services purchases on open account amount to P672,000 as of
March 31, 2010.

Dividends

On March 10, 2010, Atimonan’s board of directors declared a cash dividend of P0.30 per o rdinary share
and a 10% ordinary share dividend. Both dividends were to be distributed on April 5, 2010 to shareholders
on record at the close of business on March 31, 2010. As of March 31, 2010 Atimonan has 6 million, P2
par value, ordinary shares issued and outstanding.

Bonds payable

Atimonan issued P6,000,000, 12% bonds, on October 1, 2004 at 96. The bonds will mature on October 1,
2014. Interest is paid semi-annually on October 1 and April 1. Atimonan uses the straight line method to
amortize bond discount.

QUESTIONS:

Based on the foregoing information, determine the adjusted balances of the following as of March 31,2010:

1. Estimated warranty payable

a. P414,000 c. P 302,400
b. P756,000 d. P1,058,400

2. Unamortized bond discount

a. P132,000 c. P 240,000
b. P108,000 d. P 120,000

3. Bond interest payable

a. P360,000 c. P 180,000
b. P300,000 d. P 0

4. Total current liabilities

a. P7,734,000 c. P 6,534,000
b. P6,126,000 d. P 4,734,000

5. Total noncurrent liabilities

a. P9,132,000
b. P9,240,000 c. P
d. P 9,108,000
9,000,000

Answers: 1) A 2) B 3) A 4) C 5) B

Suggested Solution:

Question No. 1

Warranty payable, 3/31/09 P 302,400

Add warranty expense accrued during 2009-2010 756,000
Total 1,058,400
Less payments during 2009-2010 644,400
Warranty payable, 3/31/10 P 414,000

Question No. 2

Bond discount, 10/1//04 (P6,000,000 x .04) P 240,000

Discount amortization, 10/1/04 to 3/31/10 (P240,000 x 5.5/10) 132,000
Bond discount, 3/31/10 P 108,000

Question No. 3

Bond interest payable, 10/1/09 to 3/31/10 (P6,000,000 x 12% x 6/12) P 360,000

Question No. 4

Notes payable – current (maturing up to 3/31/11) P 2,880,000

Accrues interest payable – Notes Payable 408,000
Estimated warranty payable (see no. 1) 414,000
Accounts payable 672,000
Cash dividend payable (6 million shares x P0.30) 1,800,000
Accrued interest payable – Bonds payable 360,000
Total current liabilities P 6,534,000

Question No. 5

Notes payable – noncurrent P 3,240,000

Bonds payable, net of discount of P108,000 5,892,000
Total noncurrent liabilities P 9,132,000

PROBLEM NO. 3 – Various current liabilities

The following information relates to Candelaria Company’s obligations as of December 31, 2010. For each
of the numbered items, determine the amount if any, that should be reported as current liability in the
Candelaria’s December 31, 2010 statement of financial position .

1. Accounts payable:
Accounts payable per general ledger control amounted to P5,440,000, net of P240,000 debit
balances in suppliers’ accounts. The unpaid voucher file included the following items that had not
been recorded as of December 31, 2010:
a) A Company – P244,000 merchandise shipped on December 31, 2010, FOB destination;
received on January 10, 2011.
b) B, Inc. – P192,000 merchandise shipped on December 26, 2010, FOB shipping point; received
on January 16, 2011.
c) C Super Services – P144,000 janitorial services for the three-month period ending January 31,
2011.
d) MERALCO – P67,200 electric bill covering the period December 16, 2010 to January 15, 2011.

On December 28, 2010, a supplier authorized Candelaria to return goods billed at P160,000 and
shipped on December 20, 2010. The goods were returned by Candelaria on December 28, 2010,
but the P160,000 credit memo was not received until January 6, 2011.

a. P5,923,200 c. P5,712,000
b. P5,601,600 d. P5,841,600

2. Payroll:
Items related to Candelaria’s payroll as of December 31, 2010 are:
Accrued salaries and wages P776,000
Payroll deductions for:
Income taxes withheld 56,000

SSS contributions
Philhealth contributions 64,000
16,000
Advances to employees 80,000

a. P776,000 c. P992,000
b. 832,000 d. P912,000

3. Litigation:

In May, 2010, Candelaria became involved in a litigation. The suit being contested, but
Candelaria’s lawyer believes there is probable that Candelaria may be held liable for damages
estimated in the range between P2,000,000 and P3,000,000 and no amount is a better estimate of
potential liability than any other amount.

a. P3,000,000
b. P 0 c.
d. P2,000,000
P2,500,000
4. Bonus obligation:
Candelaria Company’s president gets an annual bonus of 10% of net income after bonus and
income tax. Assume the tax rate of 30% and the correct income before bonus and tax is P9,600,000.
(Ignore the effects of other given items on net income.)

a. P 722,600 c. P395,000
b. P2,240,000 d. P628,000

5. Note payable:

A note payable to the Bank of the Philippine Islands for P2,400,000 is outstanding on December
31, 2010. The note is dated October 1, 2009, bears interest at 18%, and is payable in three equal
annual installment of P800,000. The first interest and principal payment was made on October 1,
2010.

a. P800,000 c. P908,000
b. P 72,000 d. P872,000

6. Purchase commitment:
During 2010, Candelaria entered in a noncancellable commitment to purchase 320,000 units of
inventory at fixed price of P5 per unit, delivery to be made in 2011. On December 31, 2010 the
purchase price of this inventory item had fallen to P4.40 per unit. The goods covered by the
purchase contract were delivered on January 28, 2011.

a. P 0 c. P1,600,000
b. P1,408,000 d. P 192,000

7. Deferred taxes:
On December 31, 2010, Candelaria’s deferred income tax account has a 2010 ending credit balance
of P772,800, consisting of the following items:
Caused by temporary differences in accounting Deferred tax

For gross profit on installment sales P376,000 Cr

For depreciation on property and equipment 576,000 Cr
For product warranty expense 179,200 Dr
P772,000 Cr

a. P772,800 c. P952,000
b. P196,800 d. P 0

8. Product warranty:
Candelaria has one year product warranty on selected items in its product line. The estimated
warranty liability on sales made during 2009, which was outstanding as of December 31, 2009,
amounted to P416,000. The warranty costs on sales made in 2010 are estimated at P1,504,000.
Actual warranty costs incurred during 2010 are as follows:
Warranty claims honored on 2009 sales P 416,000
Warranty claims honored on 2010 sales 992,000
Total warranty claims honored P 1,408,000

a. P 0 c. P1,504,000
b. P96,000 d. P 512,000

9. Premiums:
To increase sales, Candelaria Company inaugurated a promotional campaign on June 30, 2010.
Candelaria placed a coupon redeemable for a premium in each package of product sold. Each
premium costs P100. A premium is offered to customers who send in 5 coupons and a remittance
of P30. The distribution cost per premium is P20. Candelaria estimated that only 60% of the
coupons issued will be redeemed. For the six months ended December 31, 2010, the following is
available:
Packaged of product sold 160,000
Premiums purchased 16,000
Coupons redeemed 64,000
a. P1,728,000 c. P1,152,000
b. P1,600,000 d. P 576,000
10. Due to Five Six Finance company:
Candelaria’s accounting records show that as of December 31, 2010, P1,280,000 was due to Five
Six Finance Company for advances made against P1,600,000 of trade accounts receivable assigned
to the finance company with recourse.
a. P 0 c. P1,600,000
b. P 320,000 d. P1,280,000
Answers: 1)D 2)D 3)D 4)D 5)D 6)D 7)D 8)D 9)D 10)D

Suggested Solution:

Question No. 1

Accounts payable per general ledger P5,440,000

Debit balances in suppliers’ accounts 240,000
Goods in transit on 12/31/10, FOB shipping point 192,000
Unrecorded purchase return (160,000)
Accounts payable, as adjusted 5,712,000
Accrued janitorial expenses (P144,000 x 2/3) 96,000
Accrued utilities (P67,200 x 15/30) 33,600
Total P5,841,600

Question No. 2

Accrued salaries and wages P776,000

Income taxes withheld 56,000
SSS contributions payable 64,000
Philhealth contributions 16,000
Total P912,000

Question No. 3

Midpoint of the range [(P2,000,000 + P3,000,000)/2] P2,500,000

PAS 37 par. 36 states that the amount recognized as a provision should be the best estimate of the
expenditure required to settle the present obligation at the end of the reporting period. Par. 39 further
states that where there is a continuous range of possible outcomes, and each point in that range is a likely
as any other, the mid-point of the range is used.

Question No. 4

B = 10% (P9,600,000 – B – T)
T = 30% (P9,600,000 – B)
T = P2,880,000 - .3B

B = 10% [P9,600,000 – B – (P2,880,000 - .3B)]

B = 10% (P9,600,000 – B – P2,880,000 + .3B)
B = 10% (P6,720,000 - .7B)
B = P672,000 - .07B
1.07B = P672,000
B = P628,000 (rounded off)

Question No. 5

Principal amount due, 10/1/11 P800,000

Accrued interest payable (P1,600,000 x 18% x 3/12) 72,000
Total P872,000

Question No. 6

Estimated liability for purchase commitment [320,000 x (P5 – P4.40)] P192,000

If an entity has a contract that is onerous, the present obligation under the contract shall be recognized
and measured as a provision. ( PAS 37 par. 66)
 An onerous contract is a contract in which the unavoidable costs of meeting the obligations under the
contract exceed the economic benefits expected to be received under it.

Question No. 7

The revised PAS 1 par. 56 states that when an entity presents current and non-current assets, and
current and non-current liabilities, as separate classifications on the face of the statement of
financial position, it shall not classify deferred tax assets (liabilities) as current assets (liabilities).

Question No. 8

Warranty payable, 12/31/09 P 416,000

Add: Warranty expense accrued during 2010 1,504,000

Total 1,920,000

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Less: Payments during 2010 1,408,000

Warranty Payable, 12/31/10 P 512,000

Question No. 9
Estimated coupons to be redeemed (160,000 x 60%) 96,000

Less coupons redeemed 64,000

Coupons outstanding 32,000

Divide by exchange rate 5

Premiums to be issued 6,400

Multiply by net premium cost (P100 + P20 – P30) P90

Estimated liability for coupons, 12/31/10 P576,000

Question No. 10
This transaction involves assignment of accounts receivable, wherein the company obtained a loan
using the receivable as security. Accounts receivable – assigned will be included in trade and other
receivables, while the related loan will be reported under current liabilities.
PROBLEM NO. 4 Estimated liabilities – warranty and premium

Dolores’ Music Emporium carries a wide variety of music promotion techniques – warranties and premiums
– to attract customers.

Musical instrument and sound equipment are sold in a one-year warranty for replacement of parts and labor.
The estimated warranty cost, based on past experience, is 2% of sales.

The premium is offered on the recorded and sheet music. Customers receive a coupon for each peso spent
on recorded music or sheet music. Customers may exchange 200 coupons and P20 for an AM/FM radio.
Dolores pays P34 for each radio and estimates that 60% of the coupons given to customers will be
redeemed.

Dolores’ total sales for 2010 were P57,600,000 – P43,200,000 from musical instrument and sound
reproduction equipment and P14,400,000 from recorded music and sheet music. Replacement parts and
labor for warranty work totaled P1,312,000 during 2010. A total of 52,000 AM/FM radio used in the
premium program were purchased during the year and there were 9,600,000 coupons redeemed in 2010.

The accrual
purposes. method
The is used
balance by Dolores
in the accountstorelated
accounttofor the warranty
warranties and and premium
premiums oncosts for financial
January 1, 2010,reporting
were as
shown below:

Inventory of Premium AM/FM radio P 319,600

Estimated Premium Claims Outstanding 358,000

Estimated Liability from Warranties 1,088,000

QUESTIONS:

Based on the above and the result of your audit, determine the amounts that will be shown on the 2010
financial statements for the following:

1. Warranty expense
a. P 864,000 c. P1,312,000
b. P1,152,000 d. P 640,000

2. Estimated liability from warranties

a. P 864,000 c. P1,088,000
b. P1,312,000 d. P 640,000

3. Premium expense
a. P 604,800 c. P 864,000
b. P1,468,800 d. P 1,008,000
4. Inventory of AM/FM radio
a. P375,600 c. P 618,800
b. P319,600 d. P 455,600
5. Estimated liability for premiums
a. P604,800 c. P 507,600
b. 291,200 d. P 358,400

Answers: 1) A; 2) D; 3) A; 4) D; 5) B

Suggested Solution:

Question No. 1

Warranty expense (P43,200,000 x 2%) P864,000

Question No. 2

Estimated liability from warranties, 1/1/10 P1,088,000

 Add: Warranty expense for 2010 864,000

Total 1,952,000

Less: Actual expenditures for 2010 1,312,000

Estimated liability from warranties, 12/31/10 640,000

Question No. 3
Premium expense [(14,400,000 x 60%)/ 200 x P14] P604,800

Question No. 4

Inventory of premium, 1/1/10 P 319,600

Add: Premium purchases (52,000 x P34) 1,768,000

Total premium available 2,087,600

Less: Premiums issued (9,600,000/200 x P34) 1,632,000

Inventory of premium, 12/31/10 455,600

Question No. 5

Estimated premium claims outstanding, 1/1/10 P358,400

Add: Premium expense for 2010 604,800

Total 963,200

Less: Premiums issued (P 9,600,000/200 x P14) 672,000

Estimated premium claims outstanding, 12/31/10 291,200

PROBLEM NO. 5 – Provisions and contingent liabilities

The following information relates to Alabat Company as of December 31, 2010. Answer the following
questions relating to each of the independent situations as requested.

1. Beginning 2010, Alabat Company began marketing a new beer called “Red Colt.” To help promote
the product, the management is offering a special beer mug to each customer for every 20 specially
marked bottle caps of Red Colt. Alabat estimates that out of the 300,000 bottles of Red Colt sold
during 2010m only 50% of the marked bottle caps will be redeemed. For the year 2010, 8,000 mugs
were ordered by the company at a total cost of P360,000. A total of 4,500 mugs were already
distributed to customers. What is the amount of the liability that Alabat Company should report on
its December 31, 2010 statement of financial position?
a. P135,000 c. P337,500
b. P202,500 d. P360,000

2. On January 2, 2008, Alabat Company introduced a new line of products that carry a three-year
warranty against factory defects. Estimated warranty costs related to peso sales are as follows: 1%
of sales in the year of sale, 2% in the year after sales and 3% in the second year after sale.
Sales and actual warranty expenditures for the period 2008 to 2010 were as follows:

Sales Actual Warranty Expenditures

2008
2009 P100,000
250,000 P 3,750
750
2010 350,000 11,250
P700,000 P15,750

What amount should Alabat report as warranty expense in 2010?

a. P 3,500 c. P11,500
b. P 11,250 d. P21,000
3. During 2010, Alabat Company guaranteed a supplier’s P500,000 loan from a bank. On October 1,
2010, Alabat was notifies that the supplier had defaulted on the loan and filed for bankruptcy
protection. Counsel believes Alabat will probably have to pay between P250,000 and P450,000
under its guarantee. As a result of the supplier’s bankruptcy, Alabat entered into a contract in
December 2010 to retool its machines so that Alabat could accept parts from other suppliers.
Retooling costs are estimated to be P300,000. What amount should Manfred report as a liability in

its
a. December
P250,000 31, 2010, statement of financial position?
c. P350,000
b. P450,000 d. P650,000

A court case decided on 21 December 2010 awarded damages against Alabat. The judge has
announced that the amount of damages will be set at a future date, expected to be in March 2011.

Alabat has received advice from its lawyers that the amount of the damages could be anything
between P20,000 and P7,000,000. As of December 31, 2010, how much should be recognized in
the statement of financial position regarding this court case?

a. P 20,000 c. P7,000,000
b. P3,150,000 d. P 0

Alabat’s directors decided on 3 November 2010 to restructure the company’s operations as follows:
a) Factory T would be closed down and put on the market for sale.
b) 100 employees working in Factory T would be retrenched effective 30 November 2010 and
would be paid their accumulated entitlements p lus 3 months’ wages.
c) The remaining 20 employees working in Factory T would be transferred to Factory X, which
would continue operating.
d) 5-head-office staff would be retrenched effective 31 December 2010 and would be paid their
accumulated entitlements plus 3 month’s wages.

As at 31 December 2010 the following transactions and events had occurred:

! Factory T was shut down on 30 November 2010. An offer of P80M had been received for
Factory T; however there was no binding sales agreement
! The 100 employees had been retrenched, had left and their accumulated entitlements had been
paid, however an amount of P1,520,000, representing a portion of the 3 months’ wages for
the retrenched employees, had still not been paid.
!

Costs in
work ofFactory
P460,000 X.were expectedwill
The transfer to be incurred
occur on 15inJanuary
transferring
2011.the 20 employees to their new
! Four of the five-head-office staff had been retrenched, had left and their accumulated
entitlements, including the 3 months’ wages, had been paid. However one employee, D.
Terminator, remained on to complete administrative tasks relating to the closure of Factory T
and the transfer of staff to Factory X. D. Terminator was expected to stay until 31 January
2011. D. Terminator’s salary for January would be P80,000 and his retrenchment package
would be P260,000, all of which would be paid on the day he left. He estimated that he would
spend 60% of his time administering the closure of Factory T, 30% of his time administering
the transfer of staff to Factory X and the remaining 10% on general administration.

Calculate the amount of the restructuring provision to be recognized in Alabat’s financial

statements as at 31 December 2010.

a. P 116,000 c. P93,000
b. P1,828,000 d. P89,000

Answers: 1) A; 2) D; 3) C; 4) D; 5) B;

Suggested Solution:

Question No. 1
 Question No. 1

Total estimated mugs to be issued

[(300,000 x 50%)/20] 7,500

Less mugs issued 4,500

Balance 3,000

Multiply by premium cost (P360,000/8,000) 45

Estimated premium liability, 12/31/10 P135,000

Question No. 2

Warranty expense for 2010 (P350,000 x 6%) P21,000

Question No. 3

Provision for guarantee, 12/31/10

[(P250,000 + P450,000) / 2] P350,000

A provision is a liability of uncertain timing or amount. The amount recognized as a provision

shall be the best estimate of the expenditure required to settle the present obligation at the end of
the reporting period. (PAS 37 par. 36)

Where there is a continuous range of possible outcomes, and each point in that range is as likely

as any other, the mid-point of the range is used (PAS 37 par. 39)

Question No. 4

There is a present obligation and the obligating event has occurred, however the amount cannot
be reliably measured as the estimated range is too great. Therefore, no liability can be recognized.
This will only be disclosed as a contingent liability.

Question No. 5

Unpaid salaries of retrenched employees P1,520,000

D. Terminator’s retrenchment package 260,000

D. Terminator’s salary related to administration of the closure

(P80,000 x 60%) 48,000

P1,828,000

A restructuring is a program that is planned and controlled by management, and materially

changes either:

(a) The scope of a business undertaken by an entity; or

(b) The manner in which that business is conducted.

A restructuring provision shall include only the direct expenditures arising from the restructuring,
which are those that are both

(a) Necessarily entailed by the restructuring; and

(b) Not associated with the ongoing activities of the entity.

(PAS 37 par. 80)

A restructuring provision does not include such costs as:

(a) Retaining or relocating continuing staff;

(b) Investment
(c) Marketing; in
ornew systems and distribution networks.
 These expenditures relate to the future conduct of the business and are not liabilities for
restructuring at the end of the reporting period. Such expenditures are recognized on the same
basis as if they arose independently of a restructuring.

PROBLEM NO. 6 – Provisions, contingent liabilities, and contingent assets

Burdeos Corporation, a listed company, is a manufacturer of confectionery and biscuits. Its end of
reporting period is December 31 Relevant extracts from its financial statements at 31 December
2009 are as follows:

Current liabilities

Provision

Provision for warranties P270,000

Non-current liabilities

Provision

Provision for warranties P180,000

Note 36 – Contingent liabilities

Burdeos is engaged in litigation with various parties in relation to allergic reactions to

traces of peanuts alleged to have been found in packets of fruit gums. Burdeos strenuously
denies the allegations and, as at the date of authorizing the financial statements for issue,
is unable to estimate the financial effect, if any, of any costs or damages that may be
payable to the plaintiffs.

The provision for warranties at December 31, 2009 was calculated using the following
assumptions: There was no balance carried forward from the prior year.

Estimated cost of repairs – products with minor defects P1,000,000

Estimated cost of repairs – products with major defects P6,000,000

Expected % of products sold during 2009 having no

Defects in 2010 80%

Expected % of products sold during 2009 having

Minor defects in 2010 15%

Expected % of products sold during 2009 having

Major defects in 2010 5%

Expected timing of settlement of warranty payments

- Those with minor defects All in 2010

Expected timing of settlement of warranty payments 40% in 2010

- Those with major defects 60% in 2011

During the year ended December 31, 2010 the following occurred:

1. In relation to the warranty provision of P450,000 at December 31, 2009, P200,000 was paid out of
the provision. Of the amount paid, P150,000 was for products with minor defects and P50,000 was
for products with major defects, all of which related to amounts that had been expected to be paid
in 2010.
2. In calculating its warranty provision for December 31, 2010, Burdeos made the following
adjustments to the assumptions used for the prior year:
 Estimated cost of repairs – products with minor defects No change

Estimated cost of repairs – products with major defects P5,000,000

Expected % of products sold during 2010 having no

Defects in 2011 85%

Expected % of products sold during 2010 having

Minor defects in 2011 13%

Expected % of products sold during 2010 having

Major defects in 2011 2%

Expected timing of settlement of warranty payments

- Those with minor defects All in 2011

Expected timing of settlement of warranty payments 40% in 2011

- Those with major defects 60% in 2012

3. Burdeos determined that part of its plant and equipment needed an overhaul – the conveyer belt on
one of its machines would need to be replaced in about December 2011 at an estimated cost of
P250,000. The carrying amount of the conveyer belt at December 31, 2009 was P140,000. Its
original cost was P200,000..
4. Burdeos was unsuccessful in its defense of the peanut allergy case and was ordered to pay
P1,500,000 to the plaintiffs. As at December 31, 2010 Burdeos had paid P800,000.
5. Burdeos commenced litigation against one of its advisers for negligent advise given on the original
installation of the conveyers belt referred to in (4) above. In October 2010 the court found in favor
of Burdeos. The hearing for damages had not been scheduled as at the date the financial statements
for 2010 were authorized for issue. Burdeos estimated that it would receive about P425,000.
6. Burdeos signed an agreement with Craft Bank to the e Burdeos would guarantee a loan made by
Craft Bank to the subsidiary, Burgis Ltd. Burgis’ loan with Craft B P3,200,000 as at December 31,
2010. Burgis was in financial position at December 31, 2010.

QUESTIONS:

Based on the above and the result of your audit, answer the following

1. The warranty expense in 2010 is

a. P100,000 c. P400,000
b. P160,000 d. P230,000
2. The provision for warranties as of December 31, 2010 is
a. P580,000 c. P230,000
b. P480,000 d. P410,000

3. The provision for warranties to be reported as current liabilities on December 31, 2010 is
a. P220,000 c. P150,000
b. P400,000 d. P330,000
4. The provision for warranties to be reported as noncurrent as of December 21, 2010 is

a. P 80,000 c. P260,000
b. P150,000 d. P330,000
5. Total provisions to be reported in the statement of financial position as of December 31, 2010 is
a. P 480,000 c. P 410,000
b. P1,180,000 d. P1,360,000

Answers: 1) B; 2) D; 3) A; 4) A; 5) C

Suggested Solution:

Question No. 1

No defects – 85% P 0

Minor defects (P1,000,000 x 13%) 130,000

Major defects (P5,000,000 x 2%) 100,000

Increase in provision in 2010 230,000

Unused amounts reversed in 2010 (P270,000 – P200,000) ( 70,000)

 Warranty Expense in 2010 P 160,000

Where the provision being measured involves a large population of items, the obligation is estimated by
weighing all possible outcomes by their associated probabilities. The name for this statistical method of
estimation is ‘expected value’.

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Question No. 2

Balance, 1/1/10 (P270,000 + 180,000) P450,000

Amounts used in 2010 (200,000)

Increase in provision in 2010 230,000

Unused amounts reversed in 2010 ( 70,000)

Balance, 12/31/10 P 410,000

Alternative computation:

Increase in provision in 2010 P230,000

Balance of provision from 2009 payable in 2011 180,000

Balance, 12/31/10 P410,000

A provision shall be used only for expenditures for which the provision was originally recognized.

Provisions shall be reviewed at the end of each reporting period and adjusted to reflect the current best
estimate. If it is no longer probable that an outflow of resources embodying economic benefits will be
required to settle the obligation, the provision shall be reversed.

Question No. 3

Balance of provision from 2009 payable in 2011 P 180,000

Increase in provision in 2010

Minor defects 130,000

Major defects (P100,000 x 20%) 20,000

Provision for warranties – current P 330,000

Question No. 4

Provision for warranties, 12/31/10 P410,000

 Less current provision for warranties 330,000
Non-current provision for warranties P 80,000

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Provision for warranties, 12/31/10 + P410,000

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The other items should be treated as follows:

EXCLUSIVE OFFER
Expected overhaul – not a provision; Burdeos has no present obligation to conduct over haul. Rather, it is
evidence that the conveyer belt’s useful life has been shortened.
+
Unpaid amount of P700,000 (re peanut allergy case) – not a provision; there is no uncertainty regarding

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timing or amount of settlement. The amount should be included as part of trade and other payables.

Claim for damages against the entity’s advisers – contingent asset.

Books, audiobooks,
Guarantee – not a and more.
provision; although the entity has a present obligation under the guarantee; it is not

probable that an outflow

a strong financial of economic
position benefits
at December 31, will beThe
2010. required to settle
guarantee the obligation
would since
be disclosed asBurgis was in
a contingent
liability.

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PROBLEM NO. 7 – Bonds Payable

Gumaca Corporation authorized the sale of P2,000,000 of 12%, 10 year debentures on January 1, 2005.
Interest is payable on January 1 and July 1. The entire issue was sold on April 1, 2005, at 102 plus accrued
interest. On April 1, 2010, P1,000,000 of the bond issue was reacquired and retired at 99 plus accrued
interest. On June 30, 2010, the remaining bonds were reacquired at 97 plus accrued interest and refunded
with an issue of P1,600,000 of 9% bonds which were sold at 100.

QUESTIONS:

Based on the above and the result of your audit. Determine the following: ( Use straight line method to
amortize premium or discount)

1. Total cash receive from the sale of P2 million bonds on April 1, 2005

a. P2,100,000 c. P2,040,000

b. P2,000,000 d. P2,120,000

2. Interest expense for 2005

a. P180,000 c. P 157,241
b. P183, 077 d. P176,923
3. Carrying amount of bonds payable as of December 31, 2005

a. P2,037,241
b. P2,042,759 c. P2,036,923
d. P2,043,077
4. Gain or loss on retirement of P1 million bonds on April 1, 2010
a. P19,744 gain c. P 256 gain
b. P19,744 loss d. P19, 828 gain
5. Gain or loss on retirement of remaining bonds on June 30, 2010
a. P39,231 loss c. P 20,679 gain
b. P39,231 gain d. P39,310 gain

Answers: 1) A; 2) D; 3) C; 4) A; 5) B

Suggested Solution:

Question No. 1

Issue price (P2,000,000 x 1.02) P2,040,000

Accrued interest (P2,000,000 x 12% x 3/12) 60,000

Total cash received from sale of bonds P2,100,000

Question No. 2

Nominal interest (P2,000,000 x 12% x 9/12) P180,000

Less premium amortization for 2005

 Less premium amortization for 2005

(P40,000* x 9/117**) 3,077

Interest expense for 2005 P176,923

*(P2,000,000 x .02)

** 120 months (10 years) – 3 months (1/1/2005 to 4/1/2005)

Question No. 3

Carrying amount, 4/1/2005 (see no. 1) P2,040,000

Less premium amortization for 2005 (see no. 2) 3,077

Carrying amount, 12/31/2005 P2,036,923

Question No. 4

Face value of bonds retired P1,000,000

Add unamortized bond premium,

(P40,000 x ½ x 57/117) 9,744

Carrying amount of bonds retired 1,009,744

Less retirement price (P1,000,000 x .99) 990,000

Gain on bond reacquisition P 19,744

Question No. 5

Face value of bonds retired P1,000,000

Add unamortized bond premium,

(P40,000 x ½ x 54/117) 9,231

Carrying amount of bonds retired 1,009,231

Less retirement price (P1,000,000 x .97) 970,000

Gain on bond reacquisition P 39,231

PROBLEM NO. 8 – Bonds payable

In your initial audit of Infanta Finance Co., you find the following ledger account balances.

Debit Credit

12%,25-year Bonds Payable, 2006 issue

01/01/2006 P6,400,000

Treasury Bonds

10/01/2010 P864,000

Bond Premium

01/01/2006 320,000

Bond Interest Expense

01/01/2010 384,000

07/01/2010 384,000

The bonds were redeemed for permanent cancellation on October 1, 2010 at 105 plus accrued interest.

QUESTIONS:

Based on the above and the result of your audit, determine the following: ( Use straight line method to
amortize premium or discount)

1. The adjusted balance of bonds payable as of December 31, 2010 is

a. P5,536,000 c. P5,600,000
b. P6,400,000 d. P4,000,000
2. The unamortized bond premium on December 31, 2010 is
a. P320,000 c. P256,000
b. P224,000 d. P235,200
3. The total bond interest expense for the year 2010 is
a. P756,400 c. P731,600
b. P755,200 d. P731,200
4. The gain or loss on partial bond redemption is
a. P7,600 loss c. P7,600 gain
b. P72,400 loss d. P72,400 gain

Answers: 1)C; 2)B; 3)C; 4)A

Suggested Solution:
Question No. 1
Question No. 1

Total bonds issued P6,400,000

Face value of bonds retired

{P864,000/[1.05+(.12x3/12)]}

Adjusted balance of bonds payable, 12/31/10

Question No. 2

Unamortized bond premium, 12/31/10

(P320,000 x 8/64 x 20/25)

Question No. 3

Nominal interest:

Remaining bonds (P5,600,000 x 12%)

Bonds retired (P800,000 x 12% x 9/12)

Less premium amortization:

Remaining bonds (P320,000/25 x 14/16

Bonds retired (P320,000/25 x 2/16 x 9/12)

Question No. 4

Face value of bonds redeemed

Unamortized bond premium

Interest rate 12% per annum
(P320,000 x 8/64 x 20.25/25)
Interest payment date March 1
Carrying amount of bonds redeemed
Maturity dates and amount:
 Maturity dates and amount:
Less retirement price (P800,000 x 1.05)
Date of maturity Amount
Loss on bond redemption
March 1, 2010 P

March 1, 2011 P
PROBLEM NO. 9 – Bonds payable
March 1, 2012 P
In connection with the audit of the company’s financial statements for
March 1, 2013
the Lucban Corporation presented to you their records. This is the Pfirst
The company issued serial bonds on April 1, 2007. Your audit showed
and the accounts as of December 31, 2010: P2,000,00
Since the corporation had excess cash, bonds of P500,000 schedule
Total
retired on face
April value The total amount paid was charged
1, 2010. P2,000,000
to serial
Date of bond March 1, 2007
Serial Bonds Payable
Total proceeds VR
3/01/2010 P500,000 P2,676,000
4/01/2007

4/01/2010 VR P495,000

Accrued Interest Payable

01/01/2010

Interest Expense
3/01/2010 VR P240,000

QUESTIONS:

Based on the information presented above and the result of your

bond outstanding method to amortize premium or discount)

1. The adjusted balance of the bonds payable account as of

a. P2,000,000 c.
b. P1,084,000 d.
2. The unamortized bond premium as of December 31, 2010
a. P66,642 c.
b. P82,444 d.
 b. P82,444 d.

3. The accrued interest payable as of December 31, 2010 is

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