Teacher S Manual Financial Acctg 2

Financial Reporting
Theory and Practice
Intermediate Financial
Accounting
Part 2
TEACHER’S MANUAL
2015
BASED ON
PHILIPPINE FINANCIAL REPORTING STANDARDS (PFRSs)
Nation’s Foremost CPA Review, Inc. (NCPAR)

4F Pelizloy Centrum (w/ CHIC-BOY), Lower Session Road, Baguio
City 2600, Philippines
Mobile Number: 09178706962
E-mail: ncpar@yahoo.com
Dear fellow teacher,
This “Teacher’s Manual” should be used solely by the teacher and for
classroom purposes only. This manual should NOT be reproduced
either manually (e.g., printing or photocopy) or electronically (e.g.,
copying or uploading to the net) without my written consent (or the
publisher’s written authorization).
If you have comments, queries or suggestions, please do not hesitate

to contact me (mobile no. 09155959322; email ad:
zeus.millan@yahoo.com).
Thanks and God bless.
Sincerely,
Zeus Vernon B. Millan

TABLE OF CONTENTS
CHAPTER 17 – CURRENT AND NONCURRENT LIABILITIES........1

Multiple Choice – Theory........................................................................1
Multiple Choice – Computational..........................................................1
Exercises..................................................................................................1
CHAPTER 18 – PROVISIONS, CONTINGENT LIABILITIES AND
CONTINGENT ASSETS...................................................................40
Multiple Choice – Theory......................................................................40
Multiple Choice – Computational........................................................40
Exercises................................................................................................40
CHAPTER 19 – EMPLOYEE BENEFITS.........................................44
Exercises................................................................................................44
CHAPTER 20 – LEASES.................................................................65
Exercises................................................................................................65
CHAPTER 21 – INCOME TAXES.....................................................82
Exercises................................................................................................82
CHAPTER 22 – SHAREHOLDERS’ EQUITY...................................96
Exercises................................................................................................96
CHAPTER 23 – SHARE-BASED PAYMENTS...............................119
Multiple Choice – Theory....................................................................119
Multiple Choice – Computational......................................................119
Exercises..............................................................................................119
CHAPTER 24 – BOOK VALUE PER SHARE................................147
Exercises..............................................................................................147
CHAPTER 25 – EARNINGS PER SHARE.....................................150
Exercises..............................................................................................150
Chapter 22 – Current Liabilities
Multiple Choice – Theory
1
B 6. D
.
2
C 7. A
.
3
A 8. D
.
4
A 9. D
.
5 10
D A
. .
Multiple choice – Computational (SET A)

Answers at a glance:
11
1. A 6. B B
.
12
2. B 7. B B
.
3. D 8. C
4. D 9. C
10
5. C A
.
Solutions:
1. A – The currently maturing notes are classified as current
liabilities.
2. B (1M x 80%) = 800,000 noncurrent; (1M – 800K) = 200,000

current
3. D
Solution:
Accounts payable-trade 750,000
Short-term borrowings 400,000
Bank loan (breach of loan covenant) 3,500,000
Other bank loan, matures June 30, 20x2 1,000,000
Total current liabilities 5,650,000
4. D
Solution:
1
Unearned
revenue
ignored beg.
Redemptions - prior yr. ignored 250,000 Sales - 20x3
Redemptions - 20x3 175,000
Estimate of sales not to
be
redeemed 25,000
end. 50,000
The gift certificates sold in 20x2 and their related redemptions are ignored
because they have expired during the current year. Hence, they do not affect
the year-end liability.
5. C (125,000 + 200,000 expiring in 20x4) + 140,000 expiring in 20x5 =

465,000 balance of unearned subscription revenue on Dec. 31, 20x3
6. B
Solution:
Two equal installments of real estate tax 12,000

Multiply by: No. of installments in a year 2
Annual real estate tax 24,000

Divide by: 12
Real estate tax expense per month 2,000
Accrued tax on warehouse - July and Aug. (2,000 x 2) 4,000

Accrued tax - Sept. and Oct. (2,000 x 2) 4,000
Real estate tax payable 8,000
7. B
Solution:
Advances from
customers
118,000 1/1/x0
Advances Advances -
applied 164,000 184,000 20x0
Advances
cancelled 50,000
12/31/x0 88,000
8. C
Solution:
2
Liability for escrow account
700,000 1/1/x9
Taxes
paid 1,720,000 1,580,000 Escrow received
Interest, net (50K x
45,000 90%)
12/31/x0 605,000
9. C
Solution:
Subscriptions
expirations: Total
20x8 125,000 200,000
20x9 140,000
125,000 340,000 465,000
10. A
Solution:
Accounts payable, unadjusted 360,000
Add back: Debit balance 50,000
Add back: Undelivered check 100,000
Accounts payable, adjusted 510,000
11. B
Solution:
Total sales inclusive of sales tax (total credit) 26,500
6%/106
Multiply by: %
Total sales taxes collected 1,500
Remittance of sales tax in February (600)

Sales taxes payable 900
12. B
Solution:
20x0 Room rentals Room nights
October - 1,100
November 110,000 1,200
December 150,000 1,800
Total 260,000 4,100
Multiply by: Tax 15% 2
Total 20x0 unpaid 39,000 8,200
3
taxes
Multiple choice – Computational (SET B)

1. C 6. D 11. D 16. B 21. A
2. A 7. B 12. A 17. A 22. C
3. D 8. A 13. C 18. A 23. A
4. A 9. D 14. A 19. B 24. D
5. D 10. A 15. A 20. C 25. A
26. C
Solutions:
1. C
Solution:
Accounts payable 8,000
Utilities payable 28,000
Accrued interest expense 24,000
Obligation to deliver own shares worth a fixed amount of
40,000
cash
Cash dividends payable 16,000
Finance lease liability 140,000
Bonds payable 480,000
Discount on bonds payable (60,000
)
Security deposit 8,000
Redeemable preference shares 56,000
Total financial liabilities 740,00
0
2. A
Solution:
a. Trade accounts payable gross of debit balance, 1,244,00
unreleased check, and postdated check 0
(1.2M + 20K + 16K + 8K)
b. Advances from customers (Credit balance in
customers’ accounts) 8,000
c. Financial liability designated at FVPL 200,000
d. Current portion of bonds payable 400,000
e. Interest payable on note payable (₱400,000 x 12% x 12,000
3/12)
g. Unearned rent 16,00
4
0
0
3. D
Solution:
a. Trade accounts payable, net of cost of goods
received on consignment (1,200,000 – 40,000) 1,160,00
0
b. Held for trading financial liabilities 200,000
c. Bank overdraft 40,000
d. Income tax payable 200,000
e. Accrued expenses 20,00
0
0
4. A 4,000,000 - the refinancing agreement is not at the discretion

of the entity. The currently maturing obligation is presented as
current liability. The refinancing agreement is disclosed in the
notes as a non-adjusting event after reporting period.
5. D None, the refinancing agreement is at the discretion of the

entity. The loan payable is presented as noncurrent.
6. D None, the refinancing is completed as of the end of reporting

period. The loan payable is presented as noncurrent.
7. B - ₱200,000 representing the accrued interest on the loan (4M x

10% x 6/12). The accrued interest is presented as current
because it is due within 12 months from the end of reporting
period. The principal of ₱4M is presented as noncurrent
because the refinancing is at the discretion of the entity.
8. A - ₱4,000,000. The loan shall be presented as current despite

the receipt of the grace period because the grace period was
received after the end of reporting period.
9. D None, the grace period was received by the end of reporting

period. The loan is presented as noncurrent.
10. A ₱4,000,000, the note is payable on demand. Only if an

enforceable promise is received by the end of the reporting
period from the creditor not to demand payment for at least 12
months from end of reporting period that the note may be
classified as noncurrent.
5
11. D
Solution:
Unadjusted accounts payable 4,000,000
FOB shipping point not yet recorded 200,000
FOB shipping point lost in transit, not yet recorded 80,000
FOB destination inappropriately recorded (60,000)
Unreleased and postdated checks (48K + 20K) 68,000
Purchase return (100,000)
Reimbursement for freight accommodation 12,000
Reimbursement for freight accommodation (20,000)
4,180,00
Adjusted accounts payable
0
12. A
Solution:
Unearned income
4,000,000 Jan. 1, 20x1
Advances Advances
earned 32,000,000 40,000,000 received
Orders
cancelled 1,200,000
Dec. 31, 20x1 10,800,000
13. C
Solution:
Unearned income – Dec. 31, 20x1 (previous problem) 10,800,000

Liability for refundable deposits (Orders cancelled) 1,200,000
Total current liability for advances received 12,000,000
14. A
Solution:
 The total receipts of ₱4,000,000 (1,000 x ₱4,000) from the sale of
contracts shall be averaged or divided by two because the
contracts are sold evenly.
 Since the contracts cover a 2-year period and are sold evenly, half
of the contracts will be earned in 20x1 and 20x2 and the other half
will be earned in 20x2 and 20x3.
 This is because the portion (first half) assumed to have been sold
on January 1, 20x1 will be earned from January 1, 20x1 to
December 31, 20x2 while the portion (second half) assumed to
have been sold on December 31, 20x1 will remain as unearned
in total in 20x1 and will be earned only from January 1, 20x2 to
December 31, 20x3. This is illustrated on the table below.
6
20x1 20x2 20x3 Total
Percentage earned - 1st
yr. 40% 60%
Percentage earned - 2nd
yr. 40% 60%
800,00 1,200,00
First half (4M ÷ 2) 2M 0 0
1,200,00
Second half (4M ÷ 2) 2M 800,000 0
800,00 2,000,00 1,200,00 4,000,00
Earned portions 0 0 0 0
The shaded amounts pertain to the portions earned during the year.
15. A 2,000,000 – the earned portion in 20x2.
16. B 1,200,000 – the earned portion in 20x3
17. A 2,000,000 – see table above
18. A (96,000,000 x 2/12) = 16,000,000
19. B
Solution:
Unearned
revenue
Subscriptions
12,000,00
revenue - 20x1 92,000,00 0 Jan. 1
(squeeze) 0 96,000,000 Receipts during 20x1
16,000,00
Dec. 31 (as computed) 0
20. C
Solution:
The entity offers two (semiannual) publications for a subscription fee
with the following shipment dates and cut-off dates.
Nov.
 Shipment dates May 1
1
 Cut-off dates April 1 Oct. 1
 Receipts from Jan. 1 to April 1 will receive the 2 semi-annual

publications for the year. Therefore, no unearned revenue will
arise from these receipts.
 Receipts from April 1 to Oct. 1 will receive the 1 of 2 semi-annual
publications for the year. Therefore, 50% of these receipts are
unearned revenue.
7
 Receipts from Oct. 1 to Dec. 31 will receive none of semi-annual
publications for the year. Therefore, 100% of these receipts are
unearned revenue.
The average monthly receipts are computed as follows:

Total receipts during the year 96,000,000
Divide by: No. of months in a year 12
Average monthly collections 8,000,000
The balance of unearned revenue as of December 31, 20x1 is

computed as follows:
Receipts from April 1 to Oct. 1 [(8M x 6) x 50%] 24,000,000
Receipts from Oct. 1 to Dec. 31 [(8M x 3) x 100%] 24,000,000
Total unearned revenue - Dec. 31, 20x1 48,000,000
The beginning balance of unearned revenue is already earned during

the period. Thus, it has no effect on the ending balance of unearned
revenue.
21. A
Solution:
Unearned revenue
ignore beg. (from prior
d year)
Prior year gift certificates ignore
redeemed in 20x1 d
Gift certificates sold and Gift certificates sold
redeemed in 20x1 2,800,000 4,000,000 during 20x1
Amount estimated not to be
redeemed (4M x 10%) 400,000
800,00
end. 0
22. C
Solution:
Liability for deposits
ignore Deposits from
d 20x1
ignore 180,00 Deposits from
Returns from 20x1 d 0 20x2
100,00 360,00
Returns from 20x2 0 0 Deposits in 20x3
8
184,00
Returns in 20x3 0
256,00
end. 0
23. A (400,000 x 0.385543) = 154,217
24. D (154,217 ‘see above’ x 110%) = 169,639
25. A
Solution:
Liability for escrow accounts
800,000 Jan. 1, 20x1
6,000,000 Escrow payments received
2,000,00 Interest on escrow funds net of
Taxes paid 0 360,000 10% service fee (400,000 x 90%)
5,160,00
Dec. 31, 20x1 0
26. C
Solution:
Utility expense for December 20x1 120,000
Advertising costs incurred in December 20x1 60,000
Rent expense from December 16 to 31, 20x1 (400K ÷ 2) 200,000
Contingent rent expense [(4.8Ma – 4M) x 5%] 40,000
Additional commission expense b 120,000
Total accrued liabilities 540,000
a
Total sales is computed as follows:
Accounts receivable
Beg. bal. 0
Total sales (cash & 4,800,00 4,000,00 Total collections from
credit ) squeeze a 0 0 cash & credit sales
800,000 Net increase
b
Additional commission expense is computed as follows:
Total commission expense (4.8M total sales x 15%) 720,000
(600,000
Commission expense paid (4M cash collections x 15%)
)
120,00
Additional commission expense
0
Exercises
1. Solution:
Accounts payable P 4,000
9
Utilities payable 14,000
Accrued interest expense 12,000
Obligation to deliver own shares
worth a fixed amount of cash 20,000
Cash dividends payable 8,000
Bonds payable 240,000
Discount on bonds payable (30,000)
Redeemable preference shares 28,000
Total financial liabilities P370,00
0
2. Solution:
a. Trade accounts payable gross of debit balance,
unreleased check, and postdated check
(600,000 + 10,000 + 8,000 + 4,000). P622,00
0
b. Advances from customers (Credit balance in 4,000
customers’ accounts)
c. Financial liability designated at FVPL 100,000
d. Current portion of bonds payable 200,000
e. Interest payable on note payable 6,000
(P200,000 x 12% x 3/12)
g. Unearned rent 8,00
0
Total current liabilities P940,00
0
3. Solution:
a. Trade accounts payable, net of cost of goods
received on consignment (600,000 – 20,000) P 580,000
b. Held for trading financial liabilities 100,000
c. Bank overdraft 20,000
d. Income tax payable 100,000
e. Accrued expenses 10,000
Total current liabilities P
810,000
4. Answer: P2,000,000
5. Answer: None
6. Answer: None
7. Answer: (2M x 10% x 6/12) = 100,000
8. Answer: 2,000,000
9. Answer: None
10. Answer: 2,000,000
10
11. Solution:
Unadjusted accounts payable
P2,000,000
a. Purchases on FOB shipping point not yet recorded 100,000
b. Purchases on FOB shipping point lost in transit, not
yet recorded 40,000
e. Purchases on FOB destination inappropriately recorded ( 30,000)
f. Unreleased checks and postdated checks (12,000 + 5,000) 34,000
g. Purchase return ( 50,000)
h. Unrecorded freight on FOB SP, freight prepaid 6,000
i. Freight shouldered on behalf of the seller ( 10,000)
Adjusted accounts payable P2,090,000
12. Solutions:
Requirement (a): Advances are non-refundable
Unearned income
2,000,000 Jan. 1, 20x1
Advances Advances
earned 16,000,000 20,000,000 received
Orders
cancelled 600,000
Dec. 31, 20x1 5,400,000
Answer to requirement (a): P5,400,000
Requirement (b): Advances are refundable

Unearned income
2,000,000 Jan. 1, 20x1
Advances 16,000,00 Advances
earned 0 20,000,000 received
Orders
cancelled 600,000
Dec. 31, 20x1 5,400,000
Unearned income – Dec. 31, 20x1 P5,400,000

Refundable deposits 600,000
Total current liability for advances received P6,000,000
13. Solutions:
20x1 20x2 20x3 Total
Percentage earned
- 1st yr. 40% 60%
11
Percentage earned
- 2nd yr. 40% 60%
First half (2M / 400,00
2) 1M 0 600,000
Second half 600,00
(2M / 2) 1M 400,000 0
400,00 1,000,00 600,00 2,000,00
Earned portions 0 0 0 0
Requirement (a): Current and noncurrent portions – December

31, 20x1
Current portion of deferred revenue

(earned portion in 20x2) P1,000,000
Noncurrent portion of deferred revenue
(earned portion in 20x3) 600,000
Total deferred revenue
(P1M less earned portion in 20x1 of P200,000) P1,600,000
Requirement (b): Service revenue – 20x2

Service revenue in 20x2 (600,000 + 400,000) P1,000,000
14. Solutions:
Requirement (a): Unearned revenue – Dec. 31
48,000,00
Total receipts during the year
0
Receipts from Nov. 1 to Dec. 31 (4M x 2) 8,000,000

Total unearned revenue - Dec. 31 8,000,000
Requirement (b): Subscriptions revenue – 20x1

Unearned revenue
6,000,000 Jan. 1
Subscriptions revenue 46,000,00 48,000,00 Receipts during
- 20x1 (squeeze) 0 0 20x1
Dec. 31 (as computed) 8,000,000
15. Solution:
48,000,00
Total receipts during the year
0
12
12,000,00
Receipts from April 1 to Oct. 1 [(4M x 6) x 1/2]
0
12,000,00
Receipts from Oct. 1 to Dec. 31 (4M x 3)
0
24,000,00
Total unearned revenue - Dec. 31
0
16. Solution:
a. Cash on hand 200,00
Unearned revenue – gift certificates 0 200,000
b. Unearned revenue – gift certificates 160,00

Sales 0 160,000
c. Unearned revenue – gift certificates 20,000
Other income – gift certificates 20,000
forfeited
d. Unearned revenue – gift certificates 4,000
Other income– gift certificates 4,000
forfeited
17. Solution:
Gift certificates sold during 20x1 P2,000,000
Gift certificates sold and redeemed in 20x1 ( 1,400,000)
Amount estimated not to be redeemed (1,000,000 x 10%) ( 200,000)
Unearned revenue – Dec. 31, 20x1 P 400,000
18. Solution:
Deposits received in 20x2 P 90,000
Deposits for containers returned in 20x3 from
deposits in 20x2 ( 50,000)
Deposits received in 20x3 180,000
Deposits for containers returned in 20x3 from
deposits in 20x3 ( 92,000)
Liability for deposits for returnable containers
– Dec. 31, 20x3 P128,000
19. Solution:
Requirement (a): Noncurrent liability – Jan. 1, 20x1
Security deposit x PV of P1 @10%, n=10 = noncurrent liability on
Jan. 1, 20x1
200,000 x 0.385543 = P77,109
13
Requirement (b): Noncurrent liability – Dec. 31, 20x1
77,109 + (77,109 x 10%) = P84,820
20. Solution:
Escrow accounts
400,00
0 Jan. 1, 20x1
3,000,00
0 Escrow payments received
Interest on escrow funds
1,000,00 net of 10% service fee
Taxes paid 0 180,000 (200,000 x 90%)
Dec. 31, 2,580,00
20x1 0
21. Solution:
Utility expense for December 20x1 P60,000
Advertising costs incurred in December 20x1 30,000
Rent expense from December 16 to 31, 20x1 (200K ÷ 2) 100,000
Contingent rent expense
[(P2.4M see T-account – P2M) x 5%] 20,000
Additional commission expense* 60,000
Total accrued liabilities P270,000
Sales on accrual basis are computed as follows:

Accounts receivable
Beg. bal. 0
Total net sales Total collections
(inclusive of cash (inclusive of cash
sales) squeezea 2,400,000 2,000,000 sales)
400,000 Net increase
a
*Total commission expense (2.4M x 15%) P 360,000
Commission expense paid (2M cash sale x 15%) ( 300,000)
Additional commission expense P 60,000
14
Chapter 23 – Noncurrent Liabilities (Part 1)
1
D
.
2
C
.
3
D
.
4
C
.
5
D
.

Solutions:
1. D
Solution:
Interest expense in 20x4 (10,000 x 12% x 10/12) 1,000
Interest expense in 20x5 [(10,000 + 1,000) x 12%] 1,320
Interest payable (compounded) - 12/31/x5 2,320
2. A
Solution:
Cash flow 20,000
PV of annuity due of 1 @11%, n=8 5.712
PV of note on Dec. 30, 20x6 114,240
Less: First installment on Dec. 31, 20x6 (20,000)
PV of note on Dec. 31, 20x6 94,240
3. B 418,250 – the cash price equivalent of the annuity purchased.
4. C (418,250 + 50,000 first payment made immediately) = 468,250

total contest prize expense
5. C (194,000 x 12.4% x 1/12) = 2,005

1. B 6. A 11. B 16. B 21. A 26. C 31. C
2. B 7. A 12. A 17. D 22. D 27. B 32. C
15
3. C 8. A 13. B 18. C 23. C 28. B 33. A
4. B 9. C 14. D 19. D 24. B 29. A 34. C
5. C 10. C 15. D 20. D 25. D 30. C 35. B
Solutions:
1. B [4,000,000 x (100% - 12%)] = 3,520,000
2. B (4,000,000 x 12% x 3/12) = 120,000
3. C (4,000,000 x 112% x 12%) = 537,600
4. B 4,000,000 – the cash price equivalent
5. C
Solution:
Trial and error approach
First trial: (at 10%)
Future cash flows x PV factor at x% = PV of note
 4,800,000 X PV of ₱1 @ 10%, n=3 = 4,000,000
 (4,800,000 x 0.751315) = 3,606,312 is not equal to 4,000,000
We need a substantially higher amount of present value. Therefore,
we need to decrease substantially the interest rate. Let’s try 6%.
Second trial: (at 6%)
 4,800,000 X PV factor at 6%, n=3 = 4,000,000
 (4,800,000 x 0.839619) = 4,030,171 is not equal to 4,000,000
We need a slightly lower amount of present value. Therefore, we
need to increase slightly the interest rate. Let’s try 7%.
Third trial: (at 7%)

 4,800,000 X PV factor at 7%, n=3 = 4,000,000
 (4,800,000 x 0.816298) = 3,918,230 is not equal to 4,000,000
In here, we need to perform interpolation. Looking at the values

derived above, we can reasonably expect that the effective interest
rate is a rate between 6% and 7%.
To perform the interpolation, we will use the following formula:

x% - 6%
7% - 6%
Where: x% again is the effective interest rate.
16
The formula is derived based on our expectation that the effective
interest rate is somewhere between 6% and 7%. Notice that the lower
rate appears in both the numerator and denominator of the formula
while x% appears in the numerator.
Let us substitute the amounts of present values computed earlier on

the formula.
4,000,000 - 4,030,171 (30,171)
= = 0.2695
3,918,230 - 4,030,171 (111,941)
The amount computed is added to 6% to derive the effective interest

rate. The effective interest rate is 6.2695% (6% + .2695%).
Interest expense in 20x1 = 6.2695% x 4,000,000 = 250,780
6. A (4,000,000 x 106.2695%) = 4,250,780
7. A (4,000,000 x PV of 1 @12%, n=3) = 2,847,121
8. A 2,847,121 x 12% = 341,655
9. C (2,847,121 x 112%) = 3,188,776
10. C (1,000,000 x PV of ordinary annuity @12%, n=4) = 3,037,349
11. B
Solution:
Interest Amortizatio Present
Date Payments expense n value
Jan. 1, 20x1 3,037,349
Dec. 31,
20x1 1,000,000 364,482 635,518 2,401,831
Dec. 31,
20x2 1,000,000 288,220 711,780 1,690,051
12. A (See amortization table above)
13. B (See amortization table above)
14. D (See amortization table above)
15. D (1,000,000 x PV of an annuity due @12%, n=4) = 3,401,831
16. B
Solution:
Date Payments Interest Amortizatio Present
17
expense n value
Jan. 1, 20x1 3,401,831
Jan. 1, 20x1 1,000,000 - 1,000,000 2,401,831
Dec. 31,
20x1 1,000,000 288,220 711,780 1,690,051
18. C (4,800,000 ÷ 6 semiannual payments) = 800,000 x PV of

ordinary annuity @5%, n=6 = 4,060,554
19. D
Solution:
Jan. 1, 20x1 4,060,554
July 1, 20x1 800,000 203,028 596,972 3,463,581
Dec. 31,
20x2 800,000 173,179 626,821 2,836,760
(203,028 + 173,179) = 376,207
21. A
Solution:
PV of 1
Cash flows @10% PVF PV
0.90909
Dec. 31, 20x1
2,400,000 n=1 1 2,181,818
0.82644
Dec. 31, 20x2
1,600,000 n=2 6 1,322,314
0.75131
Dec. 31, 20x3 800,000
n=3 5 601,052
4,105,184
22. D
Solution:
Jan. 1, 20x1 4,105,184
Dec. 31,
20x1 2,400,000 410,518 1,989,482 2,115,702
23. C (See amortization table above)
18
24. B
Solution:
The note is discounted to its present value because it is long-term
and noninterest-bearing.
Future cash flow 4,000,000
Multiply by: PV of ₱1, @12%, n=3 0.71178
2,847,12
Present value
0
The entry to record the note is as follows:

Jan. Cash on hand 2,847,12
1,
Discount on N/P (4M – 2,847,120) 0
20x
1 Note payable 1,152,88 4,000,00
0 0
25. D
Solution:
The note is discounted to its present value because it is long-term
and noninterest-bearing.
Future cash flow 4,000,000
Multiply by: PV of ₱1, @12%, n=3 0.71178
2,847,12
Present value
0
The entry to record the note is as follows:

1,
Discount on N/P (4M – 2,847,120) 0
20x
1 Note payable 1,152,88 4,000,00
Unrealized gain 0 0
1,152,88
0
26. C
Solution:
Present value Present
Future cash flows factors @12%, n=3 value
4,000,00
Principal 0 0.71178 a 2,847,120
Annual interest (4M x
3%) 120,000 2.40183 b 288,220
Total 3,135,340
a
(PV of ₱1 @12%, n=3)
b
(PV of ordinary annuity of ₱1 @12%, n=3
19
27. B
Solution:
Payments
for Interest Amortizatio Present
Date interests expense n value
Jan. 1, 20x1 3,135,340
Jan. 1, 20x2 120,000 376,240 256,240 3,391,580
Jan. 1, 20x3 120,000 406,988 286,988 3,678,572
Jan. 1, 20x4 120,000 441,428 321,428 4,000,000
28. B (See amortization table above)
29. A
Solution:
PV factors
@ 6%, n= Present
Future cash flows 6 value
4,000,00
Principal 0 0.70496 a 2,819,840
Semiannual interest (4M x
1.5%) 60,000 4.91732 b 295,039
Total 3,114,879
a
(PV of ₱1 @6%, n=6)
b
(PV of ordinary annuity of ₱1 @6%, n=6
30. C
Solution:
The present value of the note is computed as follows:
Principal + Interest Future
on outstanding cash PV Present
Date balance flows factors value
12/31/x1 1.6M + (4.8M x 3%) 1,744,000 0.89286 1,557,148
12/31/x2 1.6M + (3.2M x 3%) 1,696,000 0.79719 1,352,034
12/31/x3 1.6M + (1.6M x 3%) 1,648,000 0.71178 1,173,013

Total 4,082,195
31. C (4,000,000 x 103% x 103% x 103%) x PV of 1 @12%, n=3 =

3,111,126
32. C
Solution:
Cash PV Present
Date PV of ₱1
flows factors value
20
1/1/x PV of ₱1 @ 12%, n=3
4,000,000 a 0.71178 2,847,120
4
1/1/x PV of ₱1 @ 12%, n=4
4,000,000 a 0.635518 2,542,072
5
1/1/x PV of ₱1 @ 12%,
4,000,000 0.567427 2,269,708
6 n=5
7,658,900
33. A
Solution:
Cash PV Present
Date flows PV of ₱1 factors value
PV of ₱1 @ 12%,
1/1/x4 6,000,000 n=3 0.711780 4,270,680
PV of ₱1 @ 12%,
1/1/x5 4,000,000 n=4 0.635518 2,542,072
PV of ₱1 @ 12%,
1/1/x6 2,000,000 n=5 0.567427 1,134,854
7,947,606
34. C
Solution:
Principal amount 4,000,000
Origination fee (120,000)
Initial carrying amount of loan 3,880,000
35. B
Solution:
Discounted interest rate for a 1-year loan = Net interest expense ÷
Net loan proceeds
= [(4M x 10% x 180/360) – (200,000 x 2% x 180/360)]
÷ [4M – 200,000]
= 198,000 ÷ 3,800,000
= 5.21% (effective interest for 180 days)
= 5.21% x 2 = 10.42% (effective interest for 360 days)
Exercises
1. Solution:
July 1, Cash on hand (2M x 88%) 1,760,00
20x1 Discount on note payable (2M x 0
12%) 240,000 2,000,00
Note payable 0
to record note payable discounted at a
bank
Dec. Interest expense (2M x 12% x 6/12) 120,000
31, Discount on note payable 120,000
20x1 to recognize interest expense incurred
June Interest expense (2M x 12% x 6/12) 120,000
21
20x2 to recognize interest expense incurred
June Note payable 2,000,00
30, Cash in bank 0 2,000,00
20x2 to record settlement of note payable 0
2. Solution:
July Cash on hand (2M x 88%) 1,760,00
1, Discount on note payable (2M x 0
20x1 12%) 240,000 1,000,00
Note payable 0
Interest expenses to be recognized quarterly are computed as

follows:
Outstanding balance Fractio Interest
Date of note n expense
Sept. 30,
20x1 2,000,000 2/5 96,000
Dec. 31, 20x1 1,500,000 1.5/5 72,000
Mar. 31, 20x2 1,000,000 1/5 48,000
June 30,
20x2 500,000 .5/5 24,000
5,000,000 5/5 240,000
Sept. Note payable 500,00

30, Interest expense 0
20x1 Cash in bank 96,000 500,000
Discount on note payable 96,000
Dec. Note payable 500,00
20x1 Cash in bank 72,000 500,000
Mar. Note payable 500,00
20x2 Cash in bank 48,000 500,000
June Note payable 500,00
20x2 Cash in bank 24,000 500,000
3. Solution:
Oct. 1, Land 2,000,00
22
20x1 Note payable 0 2,000,00
to record note payable issued for land 0
31, Interest payable 60,000
20x1 to record accrued interest
Oct. 1, Interest expense (2M x 12% x 9/12) 180,000
20x2 Interest payable 60,000
Cash in bank 240,000
to record payment of accrued interest
Oct. 1, Interest expense (2M x 12% x 9/12) 180,000
Oct. 1, Note payable 2,000,00
20x3 Cash in bank 0 2,000,00
to record settlement of note payable 0
4. Solution:
Jan. 1, Land 2,000,00
20x1 Note payable 0 2,000,00
to record note payable issued for land 0
Dec. Interest expense (2M x 12%) 240,000
Dec. Interest expense [(2M + 240,000) x 268,800
31, 12%] 268,800
20x2 Interest payable
to record accrued interest
Dec. Interest expense 301,056
31, [(2M + 240K + 268,800) x 12%]
20x3 Interest payable (240,000 + 268,800) 508,800
Dec. Note payable 2,000,00
31, Cash in bank 0 2,000,00
20x3 to record settlement of note payable 0
5. Solution:
PV of note = Cash price equivalent
PV of note = 2M
Jan. Inventory 2,000,00
23
1, Discount on note payable 0
20x1 Note payable 400,000 2,400,00
0
Through “trial and error with interpolation,” the effective interest rate is
6.2695%.Through “goal seek,” the effective interest rate is
6.265856927%.
Date Interest expense Discount Present value

Jan. 1, 20x1 400,000 2,000,000
Dec. 31, 20x1 125,390 274,610 2,125,390
Dec. 31, 20x2 133,251 141,359 2,258,641
Dec. 31, 20x3 141,606 (247) 2,400,247
Dec. 31, Interest expense 125,390

20x1 Discount on note payable 125,390
Dec. 31, Note payable 2,400,00
20x3 Cash 0 2,400,00
0
6. Solution:
PV of note = 2M x PV of P1 @12%, n=4
PV of note = 1,423,560
Jan. Transportation equipment 1,623,56

1, (200K + 1,423,560) 0
20x Discount on note payable
1 (2M – 1,423,560) 576,440
Note payable 2,000,00
0
Present
Date Interest expense Discount value
Jan. 1, 20x1 576,440 1,423,560
Dec. 31, 20x1 170,827 405,613 1,594,387
Dec. 31, 20x2 191,326 214,286 1,785,714
Dec. 31, 20x3 214,286 0 2,000,000

24
Jan. 1, Note payable 2,000,00
20x4 Cash in bank 0 2,000,00
0
7. Solution:
PV of note = (2M / 4) x PV of ordinary annuity of P1 @12%, n=4
PV of note = 1,518,675

1, (200K + 1,518,675) 5
20x Discount on note payable
(2M – 1,518,675) 481,325
1
0
Jan. 1, 20x1 1,518,675
Dec. 31, 20x1 500,000 182,241 317,759 1,200,916
Dec. 31, 20x2 500,000 144,110 355,890 845,026
Dec. 31, 20x3 500,000 101,403 398,597 446,429
Dec. 31, 20x4 500,000 53,571 446,429 -

31, Interest expense 182,241
20x1 Cash in bank 500,000
25
8. Solution:
PV of note = (2M / 4) x PV of an annuity due of P1 @12%, n=4
PV of note = 1,700,916
Payment Interest Amortizatio Present

Date s expense n value
Jan. 1, 20x1 1,700,916
Jan. 1, 20x1 500,000 - 500,000 1,200,916
Dec. 31,
20x1 500,000 144,110 355,890 845,026
Dec. 31,
20x2 500,000 101,403 398,597 446,429
Dec. 31,
20x3 500,000 53,571 446,429 -

1, (200K + 1,700,916) 6
20x1 Discount on note payable
(2M – 1,700,916) 299,084
to record the note payable issued
0
Jan. Note payable 500,000
1, Cash in bank 500,000
20x1 to record the first installment payment made
in advance
9. Solution:
PV of note = (2.4M / 6) x PV of ordinary annuity of P1 @5%, n=6
PV of note = 2,030,277
Jan. 1, Machinery 2,030,277

26
(2.4M – 2,030,277) 2,400,000
Note payable

Jan. 1, 20x1 2,030,277
July 1, 20x1 400,000 101,514 298,486 1,731,791
Dec. 31, 20x1 400,000 86,590 313,410 1,418,380
July 1, 20x1 400,000 70,919 329,081 1,089,299
Dec. 31, 20x1 400,000 54,465 345,535 743,764
July 1, 20x1 400,000 37,188 362,812 380,953

Dec. 31, 20x1 400,000 19,048 380,952 0
July Note payable 400,00

20x1 Cash in bank 101,51 400,000
Discount on note payable 4 101,514
20x1 Cash in bank 86,590 400,000
20x2 Cash in bank 70,919 400,000
20x2 Cash in bank 54,465 400,000
20x3 Cash in bank 37,188 400,000
20x3 Cash in bank 19,048 400,000
27
10. Solution:
PV of P1 @10%,
Date Payments Present value
n=1, 2, and 3
Dec. 31,
20x1 1,200,000 0.90909 1,090,908
Dec. 31,
20x2 800,000 0.82645 661,160
Dec. 31,
20x3 400,000 0.75131 300,524
Total 2,400,000 2,052,592

Jan. 1, 20x1 2,052,592
Dec. 31, 20x1 1,200,000 205,259 994,741 1,057,851
Dec. 31, 20x2 800,000 105,785 694,215 363,636
Dec. 31, 20x3 400,000 36,364 363,636 -
Jan. Machinery 2,052,59

20x1 Note payable 347,408 2,400,00
0
Dec. Note payable 1,200,00
20x1 Cash in bank 205,259 1,200,00
Discount on note payable 0
205,259
11. Solution:
20x1 Note payable 576,440 2,000,00
0
Date Interest expense Discou Present value
28
nt
Jan. 1, 20x1 576,440 1,423,560
Dec. 31, 20x1 170,827 405,613 1,594,387
Dec. 31, 20x2 191,326 214,286 1,785,714
Dec. 31, 20x3 214,286 - 2,000,000

20x1
20x2
20x3
Cash in bank 0 2,000,00
0
12. Solution:
20x1 Note payable 576,440 2,000,00
Unrealized gain – “Day 1” 0
difference 576,440
Discou
Date Interest expense nt Present value
Jan. 1, 20x1 576,440 1,423,560
Dec. 31, 20x1 170,827 405,613 1,594,387
Dec. 31, 20x2 191,326 214,286 1,785,714
Dec. 31, 20x3 214,286 - 2,000,000


0
29
13. Solution:
Present value
Future cash flows factors @12%, n=3 Present value
Principal 2,000,000 0.71178 1,423,560

Annual
interest 60,000 2.40183 144,110
Total 1,567,670
Interest Interest Amortizatio Present

Date payments expense n value
Jan. 1, 20x1 1,567,670
Dec. 31,
20x1 60,000 188,120 128,120 1,695,790
Dec. 31,
20x2 60,000 203,495 143,495 1,839,285
Dec. 31,
20x3 60,000 220,714 160,714 1,999,999
Jan. 1, Machinery 1,567,67

20x1 Discount on note payable 0
Cash in bank 432,330 2,000,00
0
31, Interest payable (P2M x 3%) 60,000
Jan. 1, Interest payable 60,000
Jan.1 Interest payable 60,000

0
30
14. Solution:
PV factors @ Present
Future cash flows 6%, n = 6 value
Principal 2,000,000 0.70496054 1,409,921
Semi-annual
interest 30,000 4.917324326 147,520
Total 1,557,441

Jan. 1, 20x1 1,557,441
July 1, 20x1 30,000 93,446 63,446 1,620,887
Dec. 31, 20x1 30,000 97,253 67,253 1,688,141
July 1, 20x2 30,000 101,288 71,288 1,759,429
Dec. 31, 20x2 30,000 105,566 75,566 1,834,995
July 1, 20x3 30,000 110,100 80,100 1,915,095
Dec. 31, 20x3 30,000 114,906 84,906 2,000,000

1, Discount on note payable (1M – 1
20x1 778,721) 442,559 2,000,00
Note payable 0
July Interest expense 93,446
15. Solution:
Date Principal + Interest Future PV Present
31
on outstanding cash
balance flows factors value
Dec. 31, 20x1 800K + (2.4M x 3%) 872,000 0.89286 778,574
Dec. 31, 20x2 800K + (1.6M x 3%) 848,000 0.79719 676,017
Dec. 31, 20x3 800K + (800K x 3%) 824,000 0.71178 586,507
Total 2,041,098
Interest
expens Amortizatio Present
Date Payments e n value
Jan. 1, 20x1 2,041,098
Dec. 31, 20x1 872,000 244,932 627,068 1,414,030
Dec. 31, 20x2 848,000 169,684 678,316 735,713
Dec. 31, 20x3 824,000 88,286 735,714 (1)

20x1 Note payable 358,902 2,400,00
0
16. Solution:
Future cash flow = (2M x FV of P1 @ 3%, n=3) = 2M x 1.092727 =
2,185,454
PV of note = 2,185,454 x PV of P1 @12%, n=3
PV of note = 1,555,563
Jan. Machinery 1,555,563444,43

20x Note payable 2,000,00
1 0
32
Dis-
PV of count
Interest Interest PV of
future Amor- on
expens payabl Note
cash tization note
e e payable
flows payabl
Date e
1,555,56 444,43
Jan. 1, 20x1 3 7 1,555,563
Dec. 31, 1,742,23 317,76

20x1 186,668 1 60,000 126,668 9 1,682,231
Dec. 31, 1,951,29 170,50

20x2 209,068 8 61,800 147,268 2 1,829,498
Dec. 31, 2,185,45

20x3 234,156 4 63,654 170,502 - 2,000,000

Jan. Interest payable 185,454
1, Note payable 2,000,00
20x4 Cash in bank 0 2,185,45
4
17. Solution:
PV of ordinary annuity of P1 @12%, n=5 3.604776
PV of ordinary annuity of P1 @12%, n=2 ( 1.690051)
PV factor for the payment period 1.914725
Multiply by: Future cash flow (6M ÷ 3 installments) P2,000,000
PV of note payable P3,829,450
18. Solution:
Cash PV Present
Date flows PV of P1 factors value
Jan. 1, PV of P1 @ 12%,
20x4 3,000,000 n=3 0.711780 2,135,340
Jan. 1, PV of P1 @ 12%,
20x5 2,000,000 n=4 0.635518 1,271,036
33
Jan. 1, PV of P1 @ 12%,
20x6 1,000,000 n=5 0.567427 567,427
3,973,803
19. Solution:
Jan. 1, Cash on hand 1,940,00
20x1 Discount on loan payable 0
Loan payable 60,000 2,000,00
0
Through “trial and error with interpolation,” the effective interest rate is
11.2357%. Through “goal seek,” the effective interest rate is
11.2326088%.
Interest Interest Amortizatio

Date payments expense n Present value
Jan. 1, 20x1 1,940,000
Dec. 31, 20x1 200,000 217,973 17,973 1,957,973
Dec. 31, 20x2 200,000 219,992 19,992 1,977,965
Dec. 31, 20x3 200,000 222,238 22,238 2,000,203

20. Solution:
Discounted interest rate for a 1-year loan = Net interest expense ÷
Net loan proceeds
= [(2M x 10% x 180/360) – (100,000 x 2% x 180/360)] ÷ [2M –
100,000]
= 99,000 ÷ 1,900,000
= 5.21% (effective interest for 180 days)
= 5.21% x 2 = 10.42% (effective interest for 360 days)
34
Chapter 24 – Noncurrent Liabilities (Part 2)
1 11
D 6. B C
. .
2 12
C 7. C B
. .
3 13
D 8. A D
. .
4 14
C 9. D C
. .
5 10 15
C C A
. . .

11 16
1. D 6. B B A
. .
12 17
2. A 7. D B D
. .
13 18
3. D 8. B D D
. .
14 19
4. C 9. D C B
. .
10 15 20
5. B C B D
. . .
Solutions:
1. D
Solution:
9¾% registered debentures, callable in 2002, due in 2007 700,000
9½% collateral trust bonds, convertible into common stock
600,000
beginning in 2000, due in 2010
Total term bonds 1,300,000
2. A
Solution:
9.375% registered bonds (₱25,000 maturing annually
beginning in 20x4)
275,000
10.0% commodity backed bonds (₱50,000 maturing
annually beginning in 20x5)
200,000
475,00
Total Serial bonds
0
35
Unsecured
9.375% registered bonds (₱25,000 maturing annually
beginning in 20x4) 275,000
11.5% convertible bonds, callable beginning in 20x9, due
2010 125,000
Total Debenture bonds 400,000
3. D (20,000 + 25,000 + 200,000) = 245,000
4. C (103,288 x 10% x 6/12) = 5,164
5. B
Solution:
Interest Payment Amortizatio Present
Date expense s n value
1/2/01 469,500
6/30/01 23,475 22,500 975 470,475
6. B
Solution:
The carrying amount of the bonds on May 1, 1999 is determined as
follows:
Face amount 1,000,000
Unamortized bond premium 62,000
Carrying amount - 5/1/99 1,062,000
The carrying amount of the bonds on October 31, 1999 is determined

as follows:
5/1/99 1,062,000
10/31/99 53,100 55,000 1,900 1,060,100
The unamortized bond premium on October 31, 1999 is determined

as follows:
Carrying amount - 10/31/99 1,060,100
Unamortized premium - 10/31/99 60,100
7. D
Solution:
The periodic cash flows are computed as follows:
Due date Amounts due Periodic
Principal Interest Cash flows
36
12/31/x1 40,000 16,000 56,000
12/31/x2 40,000 12,800 52,800
12/31/x3 40,000 9,600 49,600
12/31/x4 40,000 6,400 46,400
12/31/x5 40,000 3,200 43,200
The amortization table is prepared as follows:

12/31/x
0 190,280
12/31/x
1 19,028 56,000 36,972 153,308
12/31/x
2 15,331 52,800 37,469 115,839
12/31/x
3 11,584 49,600 38,016 77,823
12/31/x
4 7,782 46,400 38,618 39,205
12/31/x
5 3,920 43,200 39,280 (75)
8. B (800,000 x 8% x 3/12) = 16,000
9. D
Solution:
Issue price of bonds (200 x 1,000 x 101%) 202,000
Accrued interest (200 x 1,000 x 9% x 5/12) 7,500
Total proceeds 209,500
10. C
Solution:
Prese
nt
Cash flows PV factors value
1,00
Principal 0 PV of 1 @9%, n=10 0.4224 422
Interest 60 PV ordinary annuity @9%, n=10 6.4177 385
Issue price 807
11. B
Solution:
EFFECT ON DECEMBER 31, 20X1:
Using straight line method:
Discount on bonds - 1/2/x1 150,000
37
Divide by: Term 6
Annual amortization of discount 25,000

Amortization - 20x1 (25,000)

Discount on bonds - 12/31/x1 (125,000)
Carrying amount - 12/31/x1 875,000
Using effective interest method:

Date expense s n Value
1/2/x1 850,000
12/31/x
1 102,000 80,000 22,000 872,000
Carrying amounts - 12/31/x1:

Straight line (erroneous) 875,000
Effective interest method 872,000
Difference - overstatement (3,000)
EFFECT ON JANUARY 2, 20X7:

On January 2, 20x7, maturity date, there will be NO EFFECT of the
error on the carrying amount of the bonds because on this date, the
discount would have been fully amortized under both the straight
line method and the effective interest method.
12. B
Solution:
Carrying amount of bonds converted 1,300,000
Par value of shares issued (50,000 x 1) (50,000)
Share premium 1,250,000
13. D – No gain or loss is recognized when convertible bonds are

converted into equity instrument.
14. C
Solution:
Fair value of bonds without the warrants 196,000
Face amount of bonds 200,000
38
Discount on bonds (4,000)
15. B
Solution:
Redemption price (5M x 98%) 4,900,000

Less: Carrying amount of bonds:
Unamortized premium 30,000
Unamortized issue costs (50,000) 4,980,000
Gain on retirement 80,000
16. A
Solution:
Redemption price (600 x 1,000 x
102%) 612,000
Less: Carrying amount of bonds:
Face amount (600 x 1,000) 600,000
Unamortized premium 65,000 665,000
Gain on retirement 53,000
17. D
Solution:
Payment for the liability:
Cash 50,000
Carrying amount of investment
securities 375,000 425,000
Carrying amount of liability settled:
Principal 500,000
Accrued interest 75,000 575,000
Gain on settlement 150,000
18. D (185,000 carrying amt. of note - 85,000 carrying amt. of land) =

100,000 gain
19. B (28,000 – 25,000) = 3,000
20. D
Solution:
The modification is analyzed as follows:
Old terms New terms
39
Principal 1,000,000 950,000
Accrued interest 40,000 30,000
Remaining term ('n') 1 year
The present value of the modified liability is computed as follows:

PV of 1 @10%, Present
Future cash flows
n=1 value
Principal 950,000 0.90909 863,636
Interest 30,000 0.90909 27,273
Present value of the modified liability 890,908
The difference between the old liability and the new liability is tested
for substantiality.
Carrying amount of old liability
1,040,000
(1M principal + 40,000 accrued interest)
Present value of modified liability 890,908
Difference 149,092
Difference 149,092
Divide by: Carrying amount of old liability 1,040,000
14.34%
The modification is considered substantial because the modification

resulted to a present value of the new obligation different by at least
10% of the present value (carrying amount) of old obligation.
Therefore, the old liability is extinguished and the difference of
₱149,092 is recognized as gain on extinguishment.

1. D 11. A 21. C 31. A 41. C
2. B 12. A 22. B 32. B 42. B
3. C 13. B 23. C 33. D 43. C
4. C 14. A 24. D 34. A 44. D
5. B 15. C 25. C 35. A
6. A 16. D 26. A 36. A
7. C 17. A 27. B 37. D
8. D 18. B 28. A 38. B
9. D 19. D 29. B 39. D
40
10. B 20. A 30. A 40. A
Solution:
1. D 4,000,000 – the issue price
2. B
Solution:
Interest
payment Interest Amortizatio Present
Jan. 1, 20x1 3,807,852
Dec. 31, 20x1 400,000 456,942 56,942 3,864,794
4,000,000 face amount – 3,864,794 = 135,206
3. C
Solution:
Interest
Jan. 1, 20x1 4,198,948
Dec. 31, 20x1 480,000 419,894 60,106 4,138,842
4,000,000 face amount – 4,138,842 = 138,842
4. C (4,000,000 – 192,148) = 3,807,852
5. B
Solution:
Trial and error
First trial: (using 11%)
 (4M x PV of ₱1 @ 11%, n=3) + [(4M x 10%) x PV of an ordinary
annuity of ₱1 @ 11%, n=3] = 3,807,852
 (4M x 0.73119) + (400,000 x 2.44371) = 3,807,852
 (2,924,760 + 977,484) = 3,902,244 is not equal to 3,807,852
We need a lower amount. We know that discount rate and present
value have an inverse relationship. Therefore, we should increase
the rate.
Second trial: (using 12%)
annuity of ₱1 @ 12%, n=3] = 3,807,852
 (4M x 0.71178) + (400,000 x 2.40183) = 3,807,852
 (2,847,120 + 960,732) = 3,807,852 is equal to 3,807,852
41
Since 12% exactly discounts the future cash flows to the initial
carrying amount of the bonds, it shall be regarded as the effective
interest rate. No further interpolation is needed.
Interest
Jan. 1, 20x1 3,807,852
Dec. 31, 20x1 400,000 456,942 56,942 3,864,794
4,000,000 face amount – 3,864,794 carrying amt. = 135,206
6. A (3,807,852 – 179,316) = 3,628,536
7. C
Solution:
Interest
Jan. 1, 20x1 3,628,536
Dec. 31, 20x1 400,000 507,995 107,995 3,736,531
9. D
Solution:
The carrying amount of the bonds on initial recognition is computed
as follows:
Issue price before transaction costs 4,412,336
(213,388
Transaction costs (Bond issue costs) )
Carrying amount - Jan. 1, 20x1 (net issue price) 4,198,948
Trial and error

annuity of ₱1 @ 10%, n=3) = 4,198,948
 (4M x 0.751315) + (480,000 x 2.48685) = 4,198,948
 (3,005,260 + 1,193,688) = 4,198,948 is equal to 4,198,948
Since 10% exactly discounts the future cash flows to the initial
carrying amount of the bonds, it shall be regarded as the effective
interest rate. No further interpolation is needed.
Date Interest Interest Amortizatio Present

payment expense n value
42
s
Jan. 1, 20x1 4,198,948
Dec. 31,
20x1 480,000 419,895 60,105 4,138,843
10. B
Solution:
Erroneous amortization of discount using straight line:
The erroneous straight-line amortization of the discount on bonds
payable is computed as follows:
Face amount of bonds 4,000,000
(3,807,852
Cash proceeds
)
Discount on bonds payable - Jan. 1, 20x1 192,148
Divide by: Term of bonds (in years) 3
Annual amortization (straight line method) 64,049
Interest expense for 20x1 recognized under straight-line method:

400,00
Interest paid (4,000,000 x 10%) 0
64,04
Amortization of discount (see computation above) 9
464,04
Interest expense under straight-line method 9
Carrying amount of bonds on Dec. 31, 20x1 under straight-line method:

3,807,85
Carrying amount - Jan. 1, 20x1 2
Amortization of discount (see computation
above) 64,049
3,871,90
Carrying amount - Dec. 31, 20x1 1
Amortization of discount under effective interest method:

Amortization table:
Jan. 1, 20x1 3,807,852
Dec. 31, 20x1 400,000 456,942 56,942 3,864,794
Effect on carrying amount of bonds as of Dec. 31, 20x1

Carrying amounts on Dec. 31, 20x1:
Straight-line 3,871,901
Effective interest rate
43
3,864,794
Difference - overstatement under straight-line 7,107
The carrying amount of the bonds on December 31, 20x1 under the
straight line method is overstated by ₱7,107.
11. A
Solution:
Effect on 20x1 profit
Interest expense in 20x1:
Straight-line (see computations above) 464,049
Effective interest rate (see computations above) 456,942
Difference - overstatement under straight-line 7,107
Since interest expense under straight-line is overstated, the profit

under straight-line is understated by ₱7,107.
12. A
Solution:
Cash proceeds including accrued interest (4M x
97%) 3,880,000
Accrued interest sold (4M x 12% x 3/12) (120,000)
Carrying amount of the bonds, April 1, 20x1 3,760,000
13. B Cash proceeds excluding accrued interest (4M x 97%)

3,880,000
14. A
Solution:
Future cash PV Present
flows PV @ 10%, n=3 factors value
Principal 4M PV of ₱1 0.751315 3,005,260
Interest 480K PV of ord. annuity of ₱1 2.486852 1,193,689
4,198,949
15. C
Solution:
Date payment expense n value
Jan. 1,
20x1 4,198,949
Apr. 1,
20x1 120,000 104,974 15,026 4,183,923
Issue price pertaining to bonds only 4,183,923

120,00
Accrued interest sold (4M x 12% x 3/12) 0
44
Total issue price or cash proceeds 4,303,923
16. D
Solution:
Jan. Bonds payable – old 32,000,00
1, Loss on extinguishment of bonds (squeeze) 0
20x1
Discount on bonds payable – old 3,160,000 1,360,000
Cash in bank 33,800,000
(32M + 1.6M call premium + 200K reacquisition
costs)
17. A
Solution:
Interest
Jan. 1, 20x1 4,303,264
Dec. 31,
480,000 430,328 49,672 4,253,592
20x1
Dec. 31,
480,000 425,360 54,640 4,198,948
20x2
July 1, 20x3 240,000 209,948 30,052 4,168,896
Carrying amount of bonds retired: (see table above) 4,168,896

Retirement price (Call price):
Retirement price including payment for
accrued interest (4M x 102%) 4,080,000
Accrued interest (4M x 12% x 6/12) (240,000) 3,840,000
Gain on extinguishment of bonds 328,896
18. B
Solution:
Interest on
outstanding
Principal principal Interest Total
Date payments balance payments payments
Dec. 31, 4,000,00 12,000,000 x 1,200,00
20x1 0 10% 0 5,200,000
Dec. 31, 4,000,00
20x2 0 8,000,000 x 10% 800,000 4,800,000
Dec. 31, 4,000,00
20x3 0 4,000,000 x 10% 400,000 4,400,000
Total Interest Amortizatio Present

Jan. 1,
20x1
11,601,220
45
Dec. 31,
20x1
5,200,000 1,392,148 3,807,852 7,793,368
19. D
Solution:
The initial carrying amount is computed as follows:
Issue price before transaction costs (12M x 105%) 12,600,000
(177,096
Transaction costs (Bond issue costs) )
Carrying amount - Jan. 1, 20x1 (net issue price) 12,422,904
Interest on
outstanding
Dec. 31, 4,000,00 12,000,000 x 1,200,00
20x1 0 10% 0 5,200,000
Dec. 31, 4,000,00
20x2 0 8,000,000 x 10% 800,000 4,800,000
Dec. 31, 4,000,00
20x3 0 4,000,000 x 10% 400,000 4,400,000
Trial and error:

 (5,200,000 x PV of ₱1 @9%, n=1) + (4,800,000 x PV of ₱1 @9%,
n=2) + (4,400,000 x PV of ₱1 @9%, n=3) = 12,422,904
 (5.2M x 0.91743) + (4.8M x 0.84168) + (4.4M x 0.77218) =
12,422,904
 (4,770,636 + 4,040,064 + 3,397,592) = 12,208,292 is not equal
to 12,422,904
We need a higher amount; therefore, we should decrease the rate.
Second trial: (using 8%)
 Future cash flows x PV factor at x% = Present value
 (5,200,000 x PV of ₱1 @8%, n=1) + (4,800,000 x PV of ₱1 @8%,
n=2) + (4,400,000 x PV of ₱1 @8%, n=3) = 12,422,904
 (5.2M x 0.925926) + (4.8M x 0.857339) + (4.4M x 0.793832) =
12,422,904
 (4,814,815 + 4,115,227 + 3,492,861) = 12,422,903 is equal to
12,422,904
The effective interest rate is 8%. No further interpolation is needed.
Date Total Interest Amortization Present
46
payment
s expense value
Jan. 1, 20x1 12,422,904
Dec. 31, 5,200,00
993,832 4,206,168 8,216,736
20x1 0
20. A
Solution:
Interest on
outstanding
Dec. 31, 4,000,00 12,000,000 x 1,200,00
20x1 0 10% 0 5,200,000
Dec. 31, 4,000,00
20x2 0 8,000,000 x 10% 800,000 4,800,000
Dec. 31, 4,000,00
20x3 0 4,000,000 x 10% 400,000 4,400,000
Total
Present
payment PV of ₱1 PVF
value
s
5,200,000 PV of ₱1 @ 12%, n=1 0.892857 4,642,856
4,800,000 PV of ₱1 @ 12%, n=2 0.797194 3,826,531
4,400,000 PV of ₱1 @ 12%, n=3 0.711780 3,131,832
11,601,21
9
21. C
Solution:
Total Interest Amortizatio Present
Jan. 1,
20x1
11,601,220
Sept. 30,
20x1
3,900,000 1,044,110 2,855,890 8,745,330
8,745,330 + (12M x 10% x 9/12) accrued interest sold = 9,645,330
22. B (12M x 110% x 110% x 110%) x PV of 1 @18%, n=3 =

9,721,052
23. C
Solution:
4,000,00
Issue price
0
Fair value of debt instrument without equity feature (4M x (3,920,000
98%) )
47
Equity component 80,000
Allocation of
Allocated amounts transaction
Component from issue price Fraction costs
3,920/4,00
Debt component 3,920,000 0 196,000
Equity
component 80,000 80/4,000 4,000
4,000,000 4,000/4,000 200,000
80,000 – 4,000 = 76,000
24. D
Solution:
Principal 4M PV of ₱1 0.711780 2,847,120
PV of ordinary annuity of 2.401831 960,732
Interest 400K ₱1
Fair value of debt instrument without conversion
feature 3,807,852
The issue price is allocated to the liability and equity components as

follows:
Issue price (4M x 105%) 4,200,000
Fair value of debt instrument without equity
feature (3,807,852)
392,14
Equity component
8
The entry to record the issuance is as follows:

Jan. Cash in bank (4M x 105%) 4,200,00
1, 0
Disc. on bonds payable (4M – 3,807,852)
20x
1 Bonds payable 192,148 4,000,00
Share premium – conversion 0
feature 392,148
Amortization table:
Jan. 1, 20x1 3,807,852
Dec. 31,
20x1 400,000 456,942 56,942 3,864,794
Dec. 31,
20x2 400,000 463,775 63,775 3,928,569
48
The other pertinent entries prior to conversion are as follows:
31, 56,942
Discount on bonds payable
20x1
31, 63,775
20x2
The entries on to record the conversion are as follows:

Dec. Bonds payable 4,000,00
31, Disc. on bonds payable (4M – 3,928,569) 0 71,431
20x2
Share capital a 3,200,00
Share premium (squeeze) 0
to record the conversion of bonds into equity 728,569
Dec. Share premium 80,000
31, 80,000
Cash in bank
20x2
to record the share issuance costs
Dec. Share premium – conversion feature 392,148
31, 392,148
Share premium
20x2
to reclassify the equity component of the
compound instrument within equity
a
(4M face amount ÷ ₱4,000) x 8 shares x ₱400 par value) = 3,200,000
Net increase in equity = credit to share capital of 3,200,000 + credit

to share premium of 728,569 – debit to share premium of 80,000 =
3,848,569
25. C
Solution:
The fair value of the bonds without the conversion option is computed
as follows:
Principal 4M PV of ₱1 0.751315 3,005,260
PV of ordinary annuity of
Interest 480K ₱1 2.486852 1,193,689
feature 4,198,949

follows:
Issue price (4M x 110%) 4,400,000
Fair value of debt instrument without equity feature
(4,198,949)
Equity component
49
201,051
The entry to record the issuance is as follows:

1, 0 4,000,00
Bonds payable
20x1
Premium on bonds payable (4,198,949 – 0
4M) 198,948
Share premium – conversion feature 201,052
Amortization table:
Jan. 1, 20x1 4,198,949
Dec. 31,
20x1 480,000 419,895 60,105 4,138,844
Dec. 31,
20x2 480,000 413,884 66,116 4,072,728
The entry to update the carrying amount of the bonds prior to

conversion is as follows:
Dec Interest expense 419,89
. 31,
Premium on bonds payable 5
20x
2 Cash in bank 60,105 480,00
0
The entries on to record the conversion are as follows:

Dec Bonds payable (4M x ½) 2,000,00
. 31, Premium on bonds [(4,072,728 - 4M) x ½]
0
20x
2 Sh. capital [(4M ÷1,000) x 8 x ₱400)] x36,364 1,600,00
½ 0
Share premium (squeeze) 436,364
to record the conversion of half of the bonds
into equity
Dec Share premium 80,000
. 31,
Cash in bank 80,000
20x
to record the share issuance costs
2
Dec Share premium – conversion feature 100,526
. 31, (201,051 x ½)
100,526
20x Share premium
2
to reclassify the equity component of the
compound instrument within equity
Net increase in equity

Credit to share capital 1,600,000
Credits to share premium (436,364 + 100,526) 536,890
Debit to “share premium” for the stock issuance costs (80,000)
Debit to “share premium – conversion feature” (100,526)
50
Net increase in equity as a result of the
1,956,364
conversion
26. A
Solution:
Credits to share premium (436,364 + 100,526) 536,890
Debit to “share premium” for the stock issuance (80,000
costs )
456,89
Net increase in share premium general account
0
27. B
Solution:
follows:
Issue price (4M x 110%) 4,400,000
feature (4,198,948)
Equity component
201,052
28. A
Solution:
Jan. 1,
4,198,948
20x1
Dec. 31,
480,000 419,896 60,104 4,138,844
20x1
July 1,
240,000 206,944 33,056 4,105,784
20x2
The entry to update the carrying amount of the bonds on conversion

date is as follows: (The problem states that the accrued interest is settled
separately in cash.)
July 1, Interest expense 206,944
20x2 33,056
Premium on bonds payable
Cash in bank (4M x 12% x 6/12) 240,00
0
The compound entry to record the conversion on December 31,

20x2 is as follows:
July Bonds payable 4,000,000
1, Premium on bonds (4,105,784 – 4M) 105,78
20x2
Share premium – conversion feature 4
Share capital (8,000 x ₱400) 201,05 3,200,00
51
Cash in bank* 2 0
1,026,83
6
*This pertains to the stock issuance costs (or conversion costs).
29. B
Solution:
The fair value of the bonds without the conversion feature is
Principal 4M PV of ₱1 0.711780 2,847,120
PV of ordinary annuity of 2.401831 960,732
Interest 400K ₱1
feature 3,807,852

follows:
4,400,00
Issue price
0
Fair value of debt instrument without equity feature (3,807,852)
The entry to record the issuance of the bonds is as follows:

Jan. 1, Cash in bank 4,400,000
20x1 Discount on bonds payable 192,148
Bonds payable 4,000,000
Share premium – conversion 592,148
feature
Amortization table:
Interest
paymen Interest Amortizatio Present
Date t expense n value
Jan. 1, 20x1 3,807,852
Dec. 31,
20x1 400,000 456,942 56,942 3,864,794
Dec. 31,
20x2 400,000 463,775 63,775 3,928,570
The other entries prior to retirement are as follows:

31, 56,942
20x1
52
31,
Discount on bonds payable 63,775
20x2
The fair value of the bonds without the conversion feature on

retirement date (December 31, 20x2) is computed as follows:
Principal 4M PV of ₱1 0.900901 3,603,604
PV of ordinary annuity of 360,360
Interest 400K ₱1 0.900901
feature 3,963,964
The retirement price is allocated to the liability and equity

components as follows:
Total retirement price 4,000,000
(3,963,964
Fair value of bonds without conversion feature – Dec. 31, 20x2
)
Equity component – debit to “share premium – conversion
feature” 36,036
The gain or loss on extinguishment of bonds is computed as follows:

3,928,57
Carrying amount of bonds – Dec. 31, 20x2
0
(3,963,964
Retirement price allocated to the bonds
)
(35,394
Loss on extinguishment of bonds
)
30. A
Solution:
The simple entries on December 31, 20x2 are as follows:
Dec Bonds payable 4,000,000
. 31, Loss on extinguishment of bonds 35,394
20x (squeeze) 71,430
2
Discount on bonds (4M – 3,928,570) 3,963,96
Cash in bank (amt. allocated to the bonds) 4
to record the retirement of convertible bonds
. 31, 36,036
Cash in bank (amount allocated to equity)
20x
to record the allocation of retirement price to
2
equity component
Dec Share prem. - conversion feature (592,148 - 556,11
. 31, 36,036)
2 556,112
20x Share premium
2 to record forfeiture of conversion feature of retired
53
convertible bonds
31. A
Solution:
Debits to “sh. prem.– conversion feature”
(36,036 + 556,112) (592,148)
Credit to share premium 556,112
Net decrease in equity (36,036)
32. B
Solution:
The fair value of the bonds without the conversion feature on
retirement date (December 31, 20x2) is computed as follows:
Principal 4M PV of ₱1 0.900901 3,603,604
PV of ordinary annuity of 360,360
Interest 400K ₱1 0.900901
feature 3,963,964
The retirement price is allocated to the liability and equity

components as follows:
2,000,00
Total retirement price
0
(1,981,982
Fair value of bonds w/o conversion feature (3,963,964 x ½)
)
feature” 18,018
The gain or loss on extinguishment of bonds is computed as follows:

1,964,28
Carrying amount of bonds converted (3,928,570* x ½)
5
Retirement price allocated to the bonds (1,981,982)
(17,699
Loss on extinguishment of bonds
)
* See amortization table in previous problem.
33. D
Solution:
The simple entries to record the retirement are as follows:
31, Loss on extinguishment of bonds 0
20x2 (squeeze) 17,699 35,717
Discount on bonds payable 1,981,98
54
Cash in bank (amount allocated to the bonds) 2
to record the retirement of convertible bonds
Dec. Share premium – conversion feature 18,018
31,
Cash in bank (amount allocated to equity) 18,018
20x2
to record the allocation of retirement price to equity
component
Dec. Share premium – conversion feature * 278,056
31,
Share premium 278,056
20x2
to record forfeiture of conversion feature of retired
convertible bonds
*(592,148 amount allocated from issue price ‘see previous problem – full
retirement’ x ½) – (18,018 amount allocated from retirement price) = 278,056
34. A
Solution:
follows:
Issue price (1,000 x ₱4,000 x 97%) 3,880,000
Fair value of debt instrument ex-warrants
(1,000 x ₱4,000 x 95%) (3,800,000)
35. A
Solution:
The entry to record the issuance of the bonds is as follows:
Jan. Cash in bank 3,880,00
1, Discount on bonds payable (4M – 0
20x 3.8M) 200,000 4,000,00
1 Bonds payable 0
Share premium – warrants outs. 80,000
The entry on Sept. 21, 20x1 is as follows:

Sept Cash in bank (1,000 x 10 x ½ x ₱480) 2,400,00
. 21, Share premium – warrants outstanding 0
20x (80,000 x ½) 40,000
1 Share capital (1,000 x10 x ½ x 2,000,00
₱400) 0
36. A
Solution:
Sept Share premium – warrants outstanding 40,00
. 21, (80,000 x ½) 0
20x Share premium 40,000
1
37. D None
55
Solution:
PV factors @10%,
Future cash flows n=3 Present value
Principal 4,000,000 0.751315 3,005,260
Interest 480,000 2.486852 1,193,689

Fair value of bonds without share warrants 4,198,949

follows:
Issue price 4,400,000
Fair value of debt instrument without the warrants ( 4,198,949)
Equity component ₱ 201,051
The entry to record the issuance of the bonds is:

1, Bonds payable 0 4,000,00
20x1 Premium on bonds payable 0
Share premium – warrants 49,737
outstanding 201,051
The entry to record the exercise of all of the share warrants is:
Sept Cash in bank (4M ÷ 4,000 x 2 x 2,080) 4,160,00
. 21, Share premium – warrants 0
20x outstanding 201,051 4,000,00
1 Share capital (4M ÷ 4,000 x 2 x 0
2,000) 361,051
Share premium
38. B (See entries above)
39. D
Solution:
Jan. Loan payable 4,000,00
1, Interest payable 0
20x Accumulated depreciation 360,000
1 Discount on loan payable 8,800,00 80,000
Equipment 0 12,000,00
Gain on extinguishment of debt 0
(squeeze) 1,080,000
40. A
Solution:
56
Carrying amount of liability (4M – 80,000 + 360,000) ₱4,280,000
Fair value of securities issued (10,000 x ₱480) ( 4,800,000)
Loss on extinguishment of debt (₱ 520,000)
41. C
Solution:
The fair value of the financial liability extinguished is computed as
follows:
Present
Future cash flows PV factors @8%, n=3 value
Principa
l 4,000,000 0.793832 3,175,328
Interest 480,000 2.577097 1,237,007
Fair value of financial liability extinguished 4,412,335
Carrying amount of liability (4M – 80,000 + 360,000) ₱4,280,000

Fair value of financial liability extinguished (4,412,335)
Loss on extinguishment of debt (₱ 132,335)
42. B
Solution:
Old terms New terms
Principal 20,000,000 16,000,000
Accrued interest 2,400,000 -
Remaining term ('n') 3 years
Nominal rate 12% 10%
Direct costs of modification 0
The present value of the future cash flows of the modified liability is
PV factors @12%, Present
Future cash flows n=3 value
Principa
l 16,000,000 0.711780 11,388,480
Interest 1,600,000 2.401831 3,842,930

Present value of the modified liability 15,231,410
The difference between the old liability and the new liability is tested
for substantiality.
Carrying amount of old liability 22,400,00
(20M principal + 2,400,000 accrued interest) 0
15,231,41
Present value of modified liability 0
57
Difference 7,168,590
22,400,00
Divide by: Carrying amount of old liability 0
32%
The entry is:

Dec.Loan payable – old 20,000,00
31,
Interest payable 0
20x1
Discount on loan payable – new 2,400,000
Loan payable – new 768,588 16,000,00
7,168,588
43. C
Solution:
Old terms New terms
Principal 20,000,000 16,000,000
Accrued interest - -
Direct costs of modification 200,000
PV factors @12%,
Principa
l 16,000,000 0.711780 11,388,480
Interest 1,600,000 2.401831 3,842,930
The difference between the old and new liabilities is tested for
substantiality.
Present value of modified liability 15,231,410
58
20,000,00
23.84%
The entry is:

Dec. Loan payable – old 20,000,00
31, Discount on loan payable – new 0
20x1 Loan payable – new 768,588 16,000,00
Cash in bank 0
Gain on extinguishment of 200,000
debt 4,568,588
44. D
Solution:
Old terms New terms
Principal 20,000,000 20,000,000
Accrued interest 600,000 -
Direct costs of modification 200,000
Present
Principa
l 20,000,000 0.711780 14,235,600
Interest 2,000,000 2.401831 4,803,662
The difference between the old and new liabilities is tested for
substantiality.
Carrying amount of old liability (20M + 600,000 accrued
int.) 20,600,000
Divide by: Carrying amount of old liability 20,600,000
7.58%
59
The modification is considered not substantial because the
modification did not result to a present value of the new obligation
different by at least 10% of the present value of old obligation (i.e.,
7.58% - below limit of ‘at least 10%’). Therefore, the old liability is not
extinguished and NO GAIN OR LOSS on extinguishment is
recognized.
Exercises
1. Solution:
1, Bonds payable (1,000 x 0 2,000,00
20x1 P2,000) 0
to record issuance of bonds at face
amount
20x1 to record interest expense
to record retirement of bonds
0
2. Solution:
1, Discount on bonds payable 7
20x1 Bonds payable 96,073 2,000,00
0
Interest
Interest expens Amortizatio Present
Date payments e n value
Jan. 1, 20x1 1,903,927
Dec. 31, 20x1 200,000 228,471 28,471 1,932,398
Dec. 31, 20x2 200,000 231,888 31,888 1,964,286
Dec. 31, 20x3 200,000 235,714 35,714 2,000,000
60
Discount on bonds 28,471
payable
payable
payable
2,000,00
Bonds payable 0 2,000,00
Cash in bank 0
3. Solution:
20x Premium on bonds payable 0
1 99,474
Interest
Jan. 1, 20x1 2,099,474
Dec. 31, 20x1 240,000 209,947 30,053 2,069,421
Dec. 31, 20x2 240,000 206,942 33,058 2,036,364
Dec. 31, 20x3 240,000 203,636 36,364 2,000,000

31, Premium on bonds payable 30,053

0
61
4. Solution:
Jan. 1, Cash on hand (2M – 96,073) 1,903,92
20x1 Bond issue cost 7
Bonds payable 96,073 2,000,00
0
Through “trial and error,” the effective interest rate is 12%.
Interest
Interest expens Amortizatio
Date payments e n Present value
Jan. 1, 20x1 1,903,927
Dec. 31, 20x1 200,000 228,471 28,471 1,932,398
Dec. 31, 20x2 200,000 231,888 31,888 1,964,286
Dec. 31, 20x3 200,000 235,714 35,714 2,000,000

31, Bond issue cost 28,471

0
5. Solution:
20x Bonds payable 185,731 2,000,00
1 0

Jan. 1, 20x1 1,814,269
Dec. 31, 20x1 200,000 253,998 53,998 1,868,267

Dec. 31, 20x2 261,557 61,557 1,929,824
62
200,000
Dec. 31, 20x3 200,000 270,175 70,175 1,999,999

31, Cash in bank 0 2,000,00
20x1 0
6. Solution:
Jan. 1, Cash on hand 2,099,47
20x1 Bonds payable 4 2,000,00
99,474
Through “trial and error,” the adjusted effective interest rate is 10%.
Interest
Jan. 1, 20x1 2,099,474
Dec. 31, 20x1 240,000 209,947 30,053 2,069,421
Dec. 31, 20x2 240,000 206,942 33,058 2,036,364
Dec. 31, 20x3 240,000 203,636 36,364 2,000,000

Cash in bank 30,053 240,000

Cash in bank 33,058 240,000

20x1
63
Cash in bank 36,364 240,000
7. Solution:
Interest
Interest expens Amortizatio
Date payments e n Present value
Jan. 1, 20x1 1,903,927
Dec. 31, 20x1 200,000 228,471 28,471 1,932,398
Face amount P2,000,000

Carrying amount – Dec. 31, 20x1 ( 1,932,398)
Unamortized discount on bond payable P 67,602
8. Solution:
Erroneous amortization of discount using straight line:
Cash proceeds 1,903,927
Face amount of bonds (2,000,000)

Divide by: Life of bonds 3 years
Annual amortization of bonds under straight line method 32,024
Interest expense for 20x1 recognized under straight line method:

Interest paid (P2M x 10%) 200,000
Amortization of discount 32,024
Interest expense under straight line method 232,024
Carrying amount of bonds as of December 31, 20x1 under straight

line method:
Carrying amount – January 1, 20x1 1,903,927
Amortization of discount under straight line 32,024
Carrying amount – December 31, 20x1 1,935,951
Amortization of discount under effective interest method:
Interest
Jan. 1, 20x1 1,903,927
Dec. 31, 20x1 200,000 228,471 28,471 1,932,398
64
Requirement (a): Effect on carrying amount of bonds as of Dec.
31, 20x1
The carrying amount of the bonds as of December 31, 20x1 under the
straight line method is overstated by P3,553 (1,935,951 –
1,932,398).
Requirement (b): Effect on 20x1 profit.

Under the straight line method, interest expense in 20x1 is P232,024
while under the effective interest method, interest expense is
P228,471 - an overstatement of P3,553. Therefore, under the straight
line method, profit for the year is understated by P3,553.
9. Solution:
Cash proceeds (4M x 97%) 3,880,000
Accrued interest sold (4M x 12% x 3/12) ( 120,000)
Carrying amount of the bonds, April 1, 20x1 3,760,000
10. Solution:
Cash proceeds excluding accrued interest (4M x 97%) 3,880,000
11. Solution:
PV Present
Future cash flows PV @ 10%, n=3 factors value
Principa 2,000,00 1,502,63

l 0 PV of P1 0.751315 0
PV of ordinary
Interest 240,000 annuity of P1 2.486852 596,844
2,099,474
12. Solution:
Jan. 1, 20x1 2,099,474
Apr. 1, 20x1 60,000 52,487 7,513 2,091,961
Issue price pertaining to bonds only P2,091,961

Accrued interest sold (2M x 12% x 3/12) 60,000
Total issue price or cash proceeds P2,151,961
13. Solution:
PV Present
Future cash flows PV @ 7%, n=6 factors value
1,332,68
Principal 2,000,000 PV of P1 0.666342 4
65
PV of ordinary
Interest 120,000 annuity of P1 4.766540 571,985
1,904,66
9
14. Solution:
Date received income n value
Jan. 1, 20x1 1,904,669
July 1, 20x1 120,000 133,327 13,327 1,917,996
Sept. 30, 20x1 60,000 67,130 7,130 1,925,126
Issue price pertaining to bonds only P 1,925,126

Sold accrued interest (2M x 12% x 3/12) 60,000
Total issue price or cash proceeds P 1,985,126
15. Solution:
Sept Bonds payable – old 16,000,00
. 30, Loss on extinguishment of bonds 0
20x (squeeze) 1,580,000
1 Discount on bonds payable 680,000
– old
0
16. Solution:
Interest Interest Amortizatio
Date payments expense n Present value
Jan. 1, 20x1 2,151,632
Dec. 31, 20x1 240,000 215,163 24,837 2,126,795
Dec. 31, 20x2 240,000 212,680 27,320 2,099,475
July 1, 20x3 120,000 104,973.7 15,026 2,084,448
Sept. Bonds payable 2,000,00

30, Premium on bonds payable 0
Cash in bank (2M x 102%) 120,000 2,040,00
Gain on extinguishment 0
of 164,448
bonds
17. Solution:
66
20x Bonds payable 199,390 6,000,00
1 0
Interest on
outstanding
Dec. 31, 2,000,00 600,00
20x1 0 6,000,000 x 10% 0 2,600,000
Dec. 31, 2,000,00 400,00
20x2 0 4,000,000 x 10% 0 2,400,000
Dec. 31, 2,000,00 200,00
20x3 0 2,000,000 x 10% 0 2,200,000
Interest Interest Present

Date payments expense Amortization value
Jan. 1, 20x1 5,800,610
Dec. 31,
20x1 2,600,000 696,073 1,903,927 3,896,683
Dec. 31,
20x2 2,400,000 467,602 1,932,398 1,964,285
Dec. 31,
20x3 2,200,000 235,714 1,964,286 (1)

31, Bonds payable 2,000,00
20x1 Cash in bank 0 2,600,00
Discount on bonds payable 0
(squeeze) 96,073
20x2 Cash in bank 0 2,400,00
(squeeze) 67,602
20x3 Cash in bank 0 2,200,00
(squeeze) 35,714
18. Solution:
Jan. 1, Cash in bank 6,211,45
20x1 (6M x 105% – 88,548) 2
67
(6M x 105%) – 6M – 88,548 211,452
Interest on
outstanding
Dec. 31, 2,000,00 6,000,000 x 600,00
20x1 0 10% 0 2,600,000
Dec. 31, 2,000,00 4,000,000 x 400,00
20x2 0 10% 0 2,400,000
Dec. 31, 2,000,00 2,000,000 x 200,00
20x3 0 10% 0 2,200,000
Through “trial and error,” the effective interest rate is 8%.

Jan. 1, 20x1 6,211,452
Dec. 31, 20x1 2,600,000 496,916 2,103,084 4,108,368
Dec. 31, 20x2 2,400,000 328,669 2,071,331 2,037,038
Dec. 31, 20x3 2,200,000 162,963 2,037,037 1

20x1 (squeeze)
0
20x2 (squeeze)
0
20x3 (squeeze) 2,000,00
Bonds payable 0
0
68
19. Solution:
Interest on
outstanding Interest
Principal principal payment Total
Date payments balance s payments
Dec. 31,
20x1 2,000,000 6M x 10% 600,000 2,600,000
Dec. 31,
20x2 2,000,000 4M x 10% 400,000 2,400,000
Dec. 31,
20x3 2,000,000 2M x 10% 200,000 2,200,000
Total PV of P1 PVF Total

payment payments
s
2,600,000 PV of P1 @ 12%, n=1 0.892857 2,321,428
2,400,000 PV of P1 @ 12%, n=2 0.797194 1,913,266
2,200,000 PV of P1 @ 12%, n=3 0.711780 1,565,916
5,800,610
20. Solution:
Interest
payment Interest Discount Principal Present
Date s expense amortization payments value
Jan. 1, 20x1 5,800,610
Sept. 30, 1,500,00
20x1 450,000 522,055 72,055 0 4,372,665
Issue price pertaining to bonds only P 4,372,665

Accrued interest sold (3,000,000 x 10% x 9/12) 450,000
Total cash proceeds P
4,822,665
21. Solution:
Face amount P6,000,000
FV of an ordinary annuity of P1 @10%, n=3 1.331
Maturity value of the bonds P7,986,000
The issue price is computed as follows:

Future cash flows P7,986,000
PV of P1 @18%, n=3 0.6086309
Present value of bonds (issue price) P4,860,526
PV of
Interest Interest Amortizatio PV of
Date cash
expense payable n bonds
flows
Jan. 1, 20x1
69
4,860,526 4,860,526
Dec. 31,
20x1 874,895 5,735,421 600,000 274,895 5,135,421
Dec. 31,
20x2 1,032,376 6,767,796 660,000 372,376 5,507,796
Dec. 31,
20x3 1,218,203 7,986,000 726,000 492,203 6,000,000

Interest payable 600,000
Dec. 31, Interest expense 1,032,37
20x2 Discount on bonds payable 6 372,376
Dec. 31, Interest expense 1,218,20
20x3 Discount on bonds payable 3 492,203
Dec. 31, Bonds payable 6,000,00
20x3 Interest payable 0
Cash in bank 1,986,00 7,986,00
0 0
22. Solution:
Jan. Cash on hand (2M x 98% - 27,602) 1,932,39
20x1 1,932,398) 67,602
0
Interest
Jan. 1, 20x1 1,932,398
Dec. 31, 20x1 200,000 231,888 31,888 1,964,286
Dec. 31, 20x2 200,000 235,714 35,714 2,000,000

31, Discount on bonds payable 31,888
Requirement (a):
70
Jan. 1, Bonds payable 2,000,00
20x3 Loss on redemption of bonds 0
(squeeze) 20,000
Cash in bank (2M x 101%) 1,020,00
0
Requirement (b):
20x3
20x4
20x5
31, Cash in bank 0 2,000,00
20x5 0
23. Solution:
Requirement (a):
Jan. Cash in bank (1,760,000 – 34,782) 1,725,21
1, Discount on redeemable preference 8
20x shares 274,782
1 Redeemable preference 2,000,00
shares 0
Interest Present
Date expense Discount value
Jan. 1, 20x1 274,782 1,725,218
Dec. 31, 20x1 51,757 223,025 1,776,975
Dec. 31, 20x2 53,309 169,716 1,830,284
Dec. 31, 20x3 54,909 114,808 1,885,192
Dec. 31, 20x4 56,556 58,252 1,941,748
Dec. 31, 20x5 58,252 (0) 2,000,000

31,
Discount on redeemable 51,757
20x1
preference shares
Mar. Interest expense (6% x P2M) 120,00
31,
Cash in bank 0 120,00
20x2
0
31,
20x2
71
preference shares
31,
20x3
preference shares
31,
20x4
preference shares
31,
20x5
preference shares
Requirement (b):
Dec. Redeemable preference shares 2,000,00
31, Loss on redemption of preference 0
20x5 shares 100,000
Cash in bank (P2M + 100,000) 2,100,00
0
Requirement (c):
Dec Redeemable preference shares 2,000,00
. 31,
Loss on redemption of pref. shares 0
20x
3 (squeeze) 514,808
Discount of redeemable 114,808
preference shares
Cash in bank (P2M + 400,000) 2,400,00
0
24. Solution:
Issue price P2,000,000
feature (2M x 98%) ( 1,960,000)
Equity component P 40,000
Allocation of
Allocated amounts transaction
Component from issue price Fraction cost
1,960/2,00
Debt component 1,960,000 0 98,000
Equity
component 40,000 40/2,000 2,000
2,000/2,00
2,000,000 0 100,000
Debt Equity
component component Totals
Allocation of issue price 1,960,000 40,000 2,000,000
72
Allocation of transaction cost (98,000) (2,000) (100,000)
Net carrying amounts 1,862,000 38,000 1,900,000

20x (2M – 1,960,000) 40,000
1 Bonds payable 2,000,00
feature 40,000
to record issuance of convertible bonds
Jan. Bond issue costs 98,000
1, Share premium – conversion feature 2,000
20x Cash in bank 100,000
1 to record transaction costs
25. Solution:
PV factors @12%,
Principal 2,000,000 0.711780 1,423,560
Interest 200,000 2.401831 480,366
feature 1,903,926
Issue price (2M x 105%) P2,100,000

Fair value of debt instrument without conversion feature ( 1,903,926)
The entry to record the issuance is:

20x 1,903,926) 96,074
1 Bonds payable 2,000,00
feature 196,074
Interest
Jan. 1, 20x1 1,903,926
Dec. 31, 20x1 200,000 228,471 28,471 1,932,397
Dec. 31, 20x2 200,000 231,888 31,888 1,964,285
Dec. 31, 20x3 200,000 235,714 35,714 1,999,999
73
31, Share premium – conversion 0
20x2 feature 196,074 35,715
(2M – 1,964,285) 1,600,00
Share capital [(P2M ÷ P1,000) x 8 0
shares x P100 par value)]
Dec. Share premium 20,000
20x2
26. Solutions:
Requirement (a):
Present
Principa
l 2,000,000 0.751315 1,502,630
Interest 240,000 2.486852 596,844
feature 2,099,474
Issue price (2M x 110%) P2,200,000


1 (2,099,474 – 2M) 99,474
Share premium – conversion
feature 100,526

Jan. 1, 20x1 2,099,474
Dec. 31, 20x1 240,000 209,947 30,053 2,069,421
74
Dec. 31, 20x2 240,000 206,942 33,058 2,036,364
Dec. 31, 20x3 240,000 203,636 36,364 2,000,000

. 31,
Premium on bonds payable 30,053
20x
1 Cash in bank 240,000
. 31,
Premium on bonds payable 33,058
20x
. 31, Premium on bonds payable [(2,036,364 – 0
20x
2M) x ½] 18,182
2
Share premium – conversion feature
(100,526 x ½) 50,263
Share capital 800,000
[(P2M ÷ 1,000) x 8 shares x P100 par value)] x
½ 268,445
Share premium (squeeze)
Dec Share premium 20,000
. 31,
Cash in bank 20,000
20x
2
Requirement (b):
Credit to share capital P800,000
Debit to “share premium – conversion feature” ( 50,263)
Debit to “share premium” for the stock issuance costs ( 20,000)
Net increase in equity as a result of the conversion P998,182
Requirement (c):
Debit to “share premium” for the stock issuance costs ( 20,000)
Net increase in share premium general account P248,445
27. Solution:
follows:
Issue price (2M x 110%) P2,200,000

Jan. 1, 20x1 2,099,474
75
Dec. 31, 20x1 240,000 209,947 30,053 2,069,421
July 1, 20x2 120,000 103,471 16,529 2,052,892

1 (2,099,474 – 2M) 99,474
Share premium – conversion
feature 100,526
. 31, Premium on bonds payable 30,053
1
2
July Bonds payable 2,000,00
1, Premium on bonds payable 0
20x (2,052,892 – 2M) 52,892
2 Share premium – conversion feature
Share capital (8,000 x P200) 100,526 1,600,00
Cash in bank 0
513,418
28. Solution:

Principal 2,000,000 0.711780 1,423,560
Interest 200,000 2.401831 480,366
feature 1,903,926

20x1 (2M – 1,903,926) 96,074
feature 296,074
76
Interest
Jan. 1, 20x1 1,903,926
Dec. 31, 20x1 200,000 228,471 28,471 1,932,397
Dec. 31, 20x2 200,000 231,888 31,888 1,964,285
Dec. 31, 20x3 200,000 235,714 35,714 1,999,999

Total retirement price P2,000,000

Fair value of bonds without conversion feature
– Dec. 31, 20x2 (1,981,982)
Equity component – debit to “share premium
– conversion feature” P 18,018
Present
Principal 2,000,000 0.900901 1,802,802
Interest 200,000 0.900901 180,180
Fair value of bonds without conversion feature -
12/31/20x2 1,981,982
Dec Bonds payable 2,000,00

. 31, Loss on extinguishment of bonds 0
20x (squeeze) 17,697
2 Discount on bonds payable 35,715
(2M – 1,964,285)
to record retirement of convertible bonds
2

. 31, Cash in bank 18,018
20x to record allocation of retirement price to
2 equity component
. 31, (296,074 –18,018)
77
20x Share premium 278,056
2 to record forfeiture of conversion feature of
retired convertible bonds
29. Solution:

Principal 2,000,000 0.711780 1,423,560
Interest 200,000 2.401831 480,366
feature 1,903,926
Interest
Jan. 1, 20x1 1,903,926
Dec. 31, 20x1 200,000 228,471 28,471 1,932,397
Dec. 31, 20x2 200,000 231,888 31,888 1,964,285
Dec. 31, 20x3 200,000 235,714 35,714 1,999,999

20x1 (2M – 1,903,926) 96,074
feature 296,074
Present
Principal 2,000,000 0.900901 1,802,802
200,00
Interest 0 0.900901 180,180
78
Fair value of bonds without conversion feature - 1,981,
12/31/20x2 982
Total retirement price P1,000,000

(1,981,982 x ½) ( 990,991)
feature” P 9,009

. 31,
Loss on extinguishment of bonds 0
20x
2 Discount on bonds payable 8,849 17,858
[(2M – 1,964,285) x ½ ] 990,99
Cash in bank 1
to record the retirement of the debt
component
. 31, (296,074 x ½)
20x
to transfer within equity the amount 8
allocated to the equity component of the
compound instrument
30. Solution:
Requirement (a):
Issue price (2,000 x P1,000 x 97%) P1,940,000
Fair value of debt instrument ex-warrants
(2,000 x P1,000 x 95%) ( 1,900,000)

20x1 (2M – 1.9M)
Share premium – warrants 40,000
outstanding
Sept Cash in bank (2,000 x 10 x ½ x P120) 1,200,00

. 21, Share premium – warrants outstanding 0
20x
(40K x ½) 20,000
1
Share capital (2,000 x 10 x ½ x P100) 1,000,00
Share premium 0
220,000
79
Requirement (b):
Sept. Share premium – warrants 20,000
21,
outstanding (40K x ½) 20,000
20x1
Share premium
31. Solution:
follows:
Fair value of debt instrument without the warrants ( 2,099,474)
Future cash flows PV factors @10%, n=3 Present value

Principa
l 2,000,000 0.751315 1,502,630
Interest 240,000 2.486852 596,844
Fair value of bonds without share warrants* 2,099,474
The entry to record the issuance of the bonds is:

1 Share premium – warrants 99,474
outstanding 100,526
The entry to record the exercise of all of the share warrants is:
Sept Cash in bank (P2M ÷ P1,000 x 2 x P520) 2,080,00
. 21, Share premium – warrants 0
20x outstanding 100,526
1 Share capital 2,000,00
(P1M ÷ P1,000 x 2 x P500) 0
Share premium
180,526
32. Solution:
20x Accumulated depreciation 180,000
1 Discount on loan payable 4,400,00 40,000
Equipment 0 6,000,00
(squeeze) 540,000
33. Solution:
80
20x1 Loss on extinguishment of debt 180,000
(squeeze) 260,000
Discount on loan payable 40,000
Share capital (10,000 x P200) 2,000,00
Share premium [(P240 – P200) x 0
10,000] 400,000
34. Solution:
Present
Principa
l 2,000,000 0.793832 1,587,664
Interest 240,000 2.577097 618,503
Fair value of financial liability extinguished 2,206,167

20x Loss on extinguishment of debt 180,000
1 (squeeze) 66,167
Discount on loan payable 40,000
Share capital (10,000 x P200) 2,000,00
Share premium (2,206,168 – 0
2M) 206,167
35. Solution:
Princip
al 8,000,000 0.711780 5,694,240
Interest 800,000 2.401831 1,921,465


(10M principal + 1,200,000 accrued interest) 0
Divide by: Present value of modified liability 7,615,705
47%
81
20x1 Discount on loan payable – new 1,200,000
(8M – 7,615,705) 384,295
Loan payable – new 8,000,00
Gain on extinguishment of 0
debt 3,584,29
5
36. Solution:
Principa
l 8,000,000 0.711780 5,694,240
Interest 800,000 2.401831 1,921,465

Divide by: Present value of modified liability 7,615,705
31%

31, Discount on loan payable – new 0
20x1 (8M – 7,615,705) 384,295
Loan payable – new 8,000,00
Cash in bank 0
Gain on extinguishment 100,000
of 2,284,29
debt 5
37. Solution:
PV factors @12%,
10,000,00
Principal 0 0.711780 7,117,800
Interest 1,000,000 2.401831 2,401,831
Carrying amount of old liability (10M + 300K accrued interest) 10,300,00
82
0
Difference 780,369
Difference 780,369
10,300,00
7.58%
Dec. Interest payable 300,000

20x1 Premium on loan payable 200,000
83
Chapter 25 – Provisions, Contingent Liabilities and
Contingent Assets
1
D
.
2
D
.
3
C
.
4
D
.
5
B
.

1. C 6. A
2. A 7. A
3. D 8. D
4. D 9. A
5. B
Solutions:
1. C
Solution:
Liability for stamp redemptions
6,000,00
0 1/1/x6
Cost of redemptions Total redemption
(stamps 2,250,00 cost of stamps
sold prior to 1/1/x6) 2,750,000 0 sold in 20x6
Cost estimate of stamps
not
to be redeemed
(20% x 2,250,000) 450,000
5,050,00
12/31/x6 0
2. A ₱200,000 – the reasonable estimate as at year-end. The actual

settlement amount of ₱275,000 is disregarded because the
settlement occurred after the financial statements have been
issued.
84
3. D 500,000 – the estimated amount.
4. D
Solution:
Warranty
liability
Actual warranty Warranty expense - 20x7
costs - 20x7 2,250 9,000 (150K x 6%)
costs - 20x8 7,500 15,000 (250K x 6%)
end. 14,250
5. B
Solution:
Liability for unredeemed coupon
Amt. 48,00 Issued on 7/1/x4 (120,000 x
disbursed 40,000 0 40%)
end. 8,000
The coupons issued on 1/1/x4 and the related disbursements are

ignored because these items have already expired during the year.
Thus, they do not affect the year-end liability.
6. A
Solution:
Liability for unredeemed coupon
Actual cost of
toys given out - 3,960 Premium expense *
3,960
The premium expense is computed as follows:

No. of packages sold 110,000
Multiply by: Estimate of redemption 60%
Total 66,000
Divide by: No. of coupons for each toy offering 5
Estimated no. of toys to be given out 13,200
Multiply by: Net cost per toy (.80 - .50) 0.30
Premium expense 3,960
7. A A contingent gain that is probable is disclosed only.
8. D The event is still considered a contingent gain with only a range

of estimated amounts as at December 31, 20x0 because the
85
actual award occurred on March 20x1, after the financial
statements has been issued on February 20x1.
9. A
Solution:
Litigation award 45,000
Less: Amount appealed (no estimate of outcome) (30,000)

Total 15,000
Litigation award 50,000
Less: Amount appealed (no estimate of outcome) (50,000)

Total -
Gain 15,000

1. B 6. C 11. B 16. A 21 D
2. A 7. D 12. A 17. A 22 B
3. B 8. A 13. A 18. A 23 A
4. A 9. B 14. A 19. D 24 E
5. C 10. D 15. B 20. B 25 D
Solution:
Best estimate
1. B 80,000,000 – the best estimate
2. A (80M x 5%) + (60M x 20%) + (40M x 35%) + (20M x 40%) =

38M
3. B (400M + 40M) ÷ 2 = 220M
4. A
Solution:
The amount of the provision is estimated as follows:
Minor repairs (40M x 3% x 10%)
120,000
Major repairs (40M x 2% x 90%)
720,000
Total
840,000
Multiply by: Present value factor (given)
0.95238
86
Total
800,000
Multiply by: Risk adjustment (100% + 6%) 106%
Total
848,000
Multiply by: Amount to be settled in 20x2 50%
Warranty provision – Dec. 31, 20x1
424,000
5. C
Solution:
At twenty per cent chance: (800K x 20%)
160,000
At eighty per cent chance: (400K x 80%)
320,000
Total 480,000
Multiply by: PV of P1 @10%, n=1 0.90909
Total 436,363
Multiply by: Risk adjustment (100% + 7%) 107%
Total 466,909
Multiply by: Probability of settlement (100% - 30%) 70%
Provision for lawsuit – Dec. 31, 20x1
326,836
6. C – same amount but the note disclosure will be modified.
7. D – the obligation is not probable, i.e., only 40% chance
8. A 200M – without deduction for reimbursement of impairment loss
9. B – disclosure only, there is no present obligation as of

December 31, 20x1 because the explosion occurred on January
1, 20x2.
10. D
11. B (3,400,000 actual settlement – 2,800,000 carrying amount of

provision) = (600,000) loss on settlement
12. A (2,400,000 actual settlement – 2,800,000 carrying amount of

provision) = 400,000 gain on settlement
13. A (0 actual settlement – 2,800,000 carrying amount of provision)

= 2,800,000 gain on settlement
87
14. A [15,000 guaranteed annual purchase x 2 years x (₱100 - ₱20)]
= 2,400,000
15. B (400,000 x 6 yrs.) – 800,000 deposit = 1,600,000
16. A 4,000,000 – termination benefits of employees terminated as a

result of the closure.
17. A (5,000 units sold x ₱400) = 2,000,000
18. A
Solution:
Estimated warranty
liability
800,00 Jan. 1, 20x1
0 (given)
Actual warranty
costs 1,240,000 2,000,000 Warranty expense
1,560,00
Dec. 31, 20x1 0
19. D
Solution:
Estimated warranty liability
- Jan. 1, 20x1
costs - 20x1 1,600,000 2,400,000 (40M x 6%)
costs - 20x2 2,000,000 2,880,000 (48M x 6%)
Dec. 31, 20x2 1,680,000
20. B
Solution:
The premium expense is computed as follows:
Sales in units 500,000
Multiply by: Estimate of wrappers to be redeemed 40%
Estimated wrappers to be presented for redemption 200,000
Divide by: Required number of wrappers for
redemption 10
Estimated number of premiums to be distributed 20,000
Multiply by: Net cost of premium
(₱800 purchase cost less ₱200 cash requirement from
customer) 600
12,000,00
Premium expense
0
88
21. D
Solution:
Estimated premium liability
- Jan. 1, 20x1
Actual cost of
premiums
distributed - Premium expense -
20x1 (60,000 x 20x1 (500,000 x
₱400) 24,000,000 32,000,000 80% ÷ 5 x ₱400 )
Actual cost of
premiums
20x2 (147,600 x 59,040,00 57,600,00 20x2 (900,000 x
₱400) 0 0 80% ÷ 5 x ₱400 )
6,560,00
Dec. 31, 20x2 0
22. B (4,000,000 x 40%) = 1,600,000 cash sales x 10% = 160,000
23. A 4,000,000
24. E – the contingent asset is not recognized.
25. D – since the contingent asset is virtually certain, it is not a

contingent asset anymore. Therefore, recognition is appropriate.
Exercises
1. Solution:
Dec. Environmental cleanup costs 40,000,00
31, Estimated liability for 0 40,000,00
20x1 cleanup costs 0
2. Solution:
Probabilit
Repair cost y Expected value
(a) (b) (c) = (a) x (b)
40,000,000 5% 2,000,000
30,000,000 20% 6,000,000
20,000,000 35% 7,000,000
10,000,000 40% 4,000,000
100% 19,000,000
Dec. Repair costs 19,000,00

31,
89
20x1 Estimated liability for repair 0 19,000,00
costs 0
3. Answer: P110M [(20M + 200M) ÷ 2].
4. Solution:
Dec. 31, Loss on fire 100,000,00
20x1 Estimated liability on 0 100,000,00
casualty 0
Dec. 31, Insurance claims 40,000,000
20x1 receivable 40,000,000
Gain on insurance
5. Solution:
Guaranteed minimum annual purchases 15,000
Multiply by: Remaining years covered by the contract
(20x2 and 20x3) 2
Total goods to be accepted in the future 30,000
Multiply by: Purchase price less salvage value
per unit (P50 – P10) P40
Loss on purchase commitment 1,200,000
Dec. Loss on purchase commitment 1,200,00

31, Estimated liability on purchase 0 1,200,00
20x1 commitment 0
6. Solution:
Rentals for the remaining lease term (200,000 x 6) P1,200,000
Deposit applied to last two years of lease ( 400,000)
Estimated liability on lease cancellation P 800,000
Dec. Probable loss on lease cancellation 1,200,00

31, Estimated liability for probable loss 0 800,00
20x1 on lease 0
Deferred charges – prepaid rent
400,00
0
7. Solution:
Dec. Employee benefits 2,000,00
31,
Estimated liability for 0 2,000,00
20x1
restructuring costs 0
8. Solutions:
Requirement (a):
90
Total units sold in 20x1 5,000
Estimated warranty cost per unit P200
Warranty expense – 20x1 P1,000,000
Requirement (b):
400,000 Jan. 1, 20x1 (given)
Warranty expense
Actual warranty costs 620,000 1,000,000 (5,000 x P200)
Dec. 31, 20x1 780,000
9. Solution:
- Jan. 1, 20x1
costs - 20x1 800,000 1,200,000 (20M x 6%)
costs - 20x2 1,000,000 1,440,000 (24M x 6%)
Dec. 31, 20x2 840,000
10. Solution:
Sales in units 1,000,000
Multiply by wrappers estimated to be presented
for redemption 40%
Estimated wrappers to be presented for redemption 400,000
Divide by: Required number of wrappers for redemption 10
Estimated number of premiums to be distributed 40,000
Multiply by: Net cost of premium (P200 purchase
cost less P50 cash requirement from customer) P150
Premium expense P6,000,000
11. Solution:
Estimated premium liability
- Jan. 1, 20x1
Actual cost of
premiums
20x1 (60,000 x 20x1 (500,000 x
P200) 12,000,000 16,000,000 80% ÷ 5 x P200 )
Actual cost of 29,520,00 28,800,00 Premium expense -
premiums 0 0 20x1 (900,000 x
distributed - 80% ÷ 5 x P200 )
20x1 (147,600 x
91
P200)
Dec. 31, 20x2 3,280,000
12. Solution:
20x Cash on hand (2M x 40%) 800,000
1 Accounts receivable (2M x 60%) 1,200,00
Sales 0 2,000,00
to record sales 0
20x Sales returns (2M x 10%) 200,000
1 Allowance for sales returns 120,000
(2M x 10% x 60%)
Estimated liability for refunds to 80,000
customers
(2M x 10% x 40%)
to record estimated sales returns
13. Solution:
Dec. 31, Probable loss on guarantee 2,000,00
20x1
Estimated liability for guarantee 0 2,000,00
0
14. Answer: None.
15. Solution:
Dec. Claims receivable (200M x 160,000,00
31, 0 160,000,00
80%)
20x1 0
Gain on settlement of
insurance
92
Chapter 26 – Employee benefits (Part 1)
1. D 6. B 11. C 16. A
2. C 7. B 12. A 17. B
3. D 8. A 13. D 18. E
4. D 9. B 14. A 19. D
5. A 10. A 15. C 20. A

Solutions:
1. C
Solution:
Liability for accumulated vacations at 12/31/X5 35,000
(20,000
Pre-20X6 accrued vacations taken from 1/1/X6 to 9/30/X6
)
Liability to be carried over to the next period 15,000
Multiply by: Increase in salary level in Oct. 20x6 10%
Additional liability due to the increase in salary level 1,500
Vacations earned in 20X6 (adjusted to current rates) 30,000
Vacation pay expense in 20x6 31,500
2. B Ryan: (800 x 2) = 1,600. None is accrued for Todd because his

vacation rights neither vest nor accumulate.
3. C
Solution:
Excess of
Sales Advances commission
perso Commission (Net (Fixed over
n sales x %) salary) advances
A (200K x 4%) = 8,000 10,000 -
(400K x 6%) =
B 24,000 14,000 10,000
(600K x 6%) =
C 36,000 18,000 18,000
Commission payable 28,000
4. C
Solution:
93
Sick leaves taken (6 employees x 3 days x ₱100) 1,800
Vacation days earned during the yr.
(6 employees x 10 days x ₱100) 6,000
Total compensated absences expense 7,800
5. D
Solution:
Vacation days available at year-end 150
Multiply by: Average salary per day 100
Adjusted liability for compensated absences 15,000
No liability is recognized for the non-vesting (non-monetized) sick

days. These are expensed when actually taken.

1. D 6. B 11. A
2. B 7. D
3. A 8. B
4. C 9. C
5. C 10. A
Solutions:
1. D
Solution:
Working days after last salary payment (Dec. 29, 30, and
31)* 3
Multiply by: Number of employees 100
Multiply by: Average pay per day 4,000
Accrued salaries – December 31, 20x1 1,200,000
*December 27 and 28 fall on weekend
2. B
Solution:
Total sick leave entitlement of employees in 20x2
(100 employees x 5 days each) 500
Sick leave expected to be taken in 20x2
(92 employees x 5 days each) (460)
Sick leave expected to be taken by the remaining 8
employees in 20x2 (8 x 6½ days each) (52)
Excess sick leave carried over from 20x1 (12)
12 x ₱4,000 = 48,000
94
3. A
Solution:
Total vacation leaves entitlement of employees in
20x1 6,000
(500 employees x 12 days each)
Vacation leaves taken in 20x1 (5,400)
Unused vacation leave carried over indefinitely 600
Multiply by: Expected pay rate in 20x2 (₱4,000 x
105%*) 4,200
Liability for unused vacation leaves 2,520,000
*100% + Average annual pay increase is 5%.
4. C
Solution:
Total vacation leaves entitlement of employees in 20x1
(500 x 12) 6,000
Vacation leaves taken in 20x1 (5,400)
Unused vacation leave carried over 600
Multiply by: 90%
Estimated vacation leaves to be taken in 20x2 540
Multiply by: Pay rate in 20x2 (₱4,000 x 105%) 4,200
2,268,00
Liability for unused vacation leaves
0
5. C
Solution:
B = P x Br
B = 4,000,000 x 10%
B = 400,000
6. B
Solution:
P
B = P -
1 + Br
4,000,000
B = 4,000,000 -
1 + 10%
3,636,36
B = 4,000,000 -
4
B = 363,636
7. D
Solution:
B = P x 1 - Tr
95
1/Br - Tr
1 - 30%
B = 4,000,000 x
1/10% - 30%
70%
B = 4,000,000 x
10 - 30%
70%
B = 4,000,000 x
9.7
B = 288,660
8. B
Solution:
1 – Tr
B = P X
1/Br - Tr + 1
70%
B = 4,000,000 x
10 - 30% + 1
70%
B = 4,000,000 x
10.7
B = 261,682
9. C
Solution:
Squeeze
upwards
Profit before bonus and before
tax 4,000,000
Bonus before tax but after bonus
(3,636,366 x 10%) (363,636)
Profit before tax but after bonus 3,636,3
(2,545,456 ÷ 70%) 66
Income tax (2,545,456 ÷ 70%) x (1,090,909
30% )
Profit after tax and after bonus 2,545,456 Start
10. A
11. A
Exercises
1. Solution:
Working days after last salary payment
(December 29, 30, and 31)* 3
Multiply by: Number of employees 100
Multiply by: Average pay per day P2,000
Accrued salaries – December 31, 20x1 P600,000
96
*December 27 and 28 fall on weekend
2. Solution:
Total sick leave entitlement of employees in 20x2
(100 employees x 5 days each) 500
Sick leave expected to be taken in 20x2
(92 employees x 5 days each) (460)
Sick leave expected to be taken by the remaining
8 employees in 20x2 (8 x 6½ days each) ( 52)
Excess sick leave carried over from 20x1 ( 12)
Accrued salaries – Dec. 31, 20x1 = (12 days x P2,000) = 24,000
3. Solutions:
Case #1:
Total vacation leaves entitlement of employees
in 20x1 (500 x 12) 6,000
Vacation leaves taken in 20x1 ( 5,400)
Multiply by: Pay rate in 20x2 (P2,000 x 105%*) 2,100
*100% + Average annual pay increase is 5%.
Case #2:
Total vacation leaves entitlement of employees in 20x1
(500 x 12) 6,000
Vacation leaves taken in 20x1 ( 5,400)
Multiply by: 90%
Estimated vacation leaves to be taken in 20x2 540
Multiply by: Pay rate in 20x2 (P2,000 x 105%) 2,100
4. Solutions:
Requirement (a):
B = P x Br
B = 2,000,000 x 10%
B = 200,000
Requirement (b):
P
B = P -
1 + Br
2,000,000
B = 2,000,000 -
1 + 10%
97
B = 2,000,000 - 1,818,181
B = 181,818
Requirement (c):
1 - Tr
B = P x
1/Br - Tr
1 - 30%
B = 2,000,000 x
1/10% - 30%
70%
B = 2,000,000 x
10 - 30%
70%
B = 2,000,000 x
9.7
B = 144,330
Requirement (d):
1 - Tr
B = P X
1/Br - Tr + 1
70%
B = 2,000,000 x
10 - 30% + 1
70%
B = 2,000,000 x
10.7
B = 130,841
5. Solution:
Profit after tax and after bonus P1,272,728
Divide by: (1 – tax rate) 70%
Profit before tax and after bonus 1,818,183
Bonus rate 10%
Bonus after bonus and before tax P 181,818
6. Solutions:
Requirement (a):
Dec. Retirement benefits expense 400,00
31, Cash in bank 0 160,000
20x1 Accrued retirement contributions
payable 240,000
31, Accrued retirement contributions 0
20x2 payable 240,00
Prepaid retirement contributions 0
260,00
0
98
Jan. No entry
12,
20x3
Requirement (b):
31, Accrued retirement benefits 0 400,000
20x1 payable
to recognize retirement benefits
expense
Dec. Retirement fund 160,00
31, Cash in bank 0 160,000
20x1 to record contributions to the fund
maintained internally
20x2 payable
expense
Dec. Retirement fund 900,00
31, Cash in bank 0 900,000
20x2 to record contributions to the fund
maintained internally
Jan. Accrued retirement benefits payable 30,000
12, Retirement fund 30,000
20x3 to record payment of retirement
benefits of retiring employee
Requirement (c):
20x1 payable
expense
20x2 payable
expense
Jan. Accrued retirement benefits payable 30,000
20x3 to record payment of retirement
benefits of retiring employee
99
Chapter 27 – Employee benefits (Part 2)

1
B 6. D A C
. 11. 16.
2
B 7. D A D
. 12. 17.
3
A 8. D A D
. 13. 18.
4
B 9. D D C
. 14. 19.
5
A 10. D D C
. 15. 20.

1. D 11. A 21. A 31. A 41. C
2. A 12. C 22. A 32. A 42. B
3. C 13. D 23. A 33. A 43. C
4. D 14. C 24. C 34. B 44. C
5. B 15. B 25. A 35. A 45. D
6. A 16. C 26. D 36. C
7. A 17. B 27. C 37. D
8. C 18. C 28. A 38. C
9. C 19. A 29. A 39. B
10. D 20. C 30. D 40. A
Solutions:
1. D
Solution: PV of defined benefit obligation
480,000 Jan. 1
Benefits paid 200,000 120,000 Current service cost
Actuarial gain - Interest cost (480K x
decrease 48,000 10%)
in PV of DBO 40,000
Dec. 31 408,000
2. A
Solution:
PV of defined benefit obligation
100
480,000 Jan. 1
Benefits 200,00 120,000
paid 0 Current service cost (squeeze)
48,000 Interest cost (480,000 x 10%)
40,000 Actuarial loss - increase in PV of
PBO
488,00
Dec. 31 0
3. C
Solution:
Final salary level (12M x 103% x 103% x 103% x 103%) 13,506,106
Multiply by: Percentage of benefit per year 6%
Benefit per year of service 810,366

Multiply by: No. of service years 5
Lump sum retirement benefit 4,051,832
4. D (13,506,106 x 6%) = 810,366 benefit entitlement per year;

(810,366 x PV of 1 @10%, n=3) = 608,840 current service cost in
20x2 *(n=3 is from December 31, 20x2 to December 31, 20x5)
5. B
Solution:
(13,506,106 x 6%) = 810,366 benefit entitlement per year;
(810,366 x PV of 1 @10%, n=3) = 553,491 current service cost in
20x1 *(n=4 is from December 31, 20x1 to December 31, 20x5)
PBO PBO
553,49
- 1/1/x1 1 1/1/x2
Bene- Current Bene- Current
fits 553,49 service fits 608,8 service
paid - 1 cost paid - 40 cost
Interest 55,3 Interest
- cost 49 cost
1,217,68
12/31/x1 553,491 12/31/x2 0
6. A – the annual benefit entitlement per year.
7. A (40,000 x 0.683013) = 27,321
8. C (40,000 x 3 x 0.826446) = 99,174
9. C 120,000 x 2% x 12 = 28,800
101
10. D
11. A (4M ÷ 10 years) = 400,000
12. C (8M ÷ 20 years) = 400,000
13. D
14. C (8M ÷ 10 years) = 800,000
15. B
16. C
Solution:
Fair value of plan assets
Jan. 1 480,000
Return on plan assets (10% x 480K) 48,000 200,000 Benefits paid
Contributions to the fund 800,000
1,128,000 Dec. 31
17. B
Solution:
Fair value of plan assets, Jan. 1 4,000,000
Present value of defined benefit obligation, Jan. 1 4,800,000
Net defined benefit liability, Jan. 1 - deficit
(excess of obligation over plan assets) (800,000)
18. C
Solution:
4,800,000 Jan. 1
Benefits
200,000 1,200,000 Current service cost
paid
480,000 Interest cost (4.8M x 10%)
6,280,00
Dec. 31
0
Fair value of plan

assets
Jan. 1 4,000,000
Benefits
Return on plan assets 480,000 200,000
paid
Contributions to the
120,000
fund
102
4,400,00
Dec. 31
0
Fair value of plan assets, Dec. 31 4,400,000

Present value of defined benefit obligation, Dec. 31 6,280,000
Net defined benefit liability, Dec. 31 - deficit (1,880,000
(excess of obligation over plan assets) )
19. A
Solution:
Surplus - Excess of plan assets over obligation 800,000

Asset ceiling - PV of refunds and reductions in future
contributions 1,000,000
Net defined benefit asset - Lower amount 800,000
20. C
Solution:

contributions 600,000
21. A (4M – 6M) = 2M
22. A
Solution:
Service cost:
(a) Current service cost 2,400,000
(b) Past service cost (200,000 + 300,000) 2,000,000
(c) (Gain) or loss on settlement 200,000
4,600,000
Net interest on the net defined benefit liability (asset):
(720,000
(a) Interest income on plan assets (7,200,000 x 10%) )
(b) Interest cost on the defined benefit obligation (8M x 800,000
10%)
103
(c) Interest on the effect of the asset ceiling -
80,000
Defined benefit cost recognized in profit or loss 4,680,000
Remeasurements of the net defined benefit liability (asset):

(a) Actuarial (gains) and losses (80,000)
(b) Difference between return on plan assets and
interest
income on plan assets (720,000 - 480,000) 240,000
(c) Difference between the change in the effect of the
asset ceiling and interest on the effect of the asset
ceiling -
Defined benefit cost recognized in OCI 160,000
Total defined benefit cost 4,840,000
23. A
Solution:
Service cost:
(a) Current service cost
2,400,000
(b) Past service cost -
(160,000
(c) (Gain) or loss on settlement
)
2,240,000
Net interest on the net defined benefit liability
(asset):
(500,000
(a) Interest income on plan assets (5,000,000 x 10%)
)
(b) Interest cost on the defined benefit obligation (6M x 10%) 600,000
(c) Interest on the effect of the asset ceiling -
100,000
Gain on change in the fair value of reimbursement (120,000
asset )

(a) Actuarial gains and losses 80,000
(100,000
interest
b )
income on plan assets
asset
ceiling and interest on the effect of the asset ceiling -
104
Defined benefit cost recognized in OCI (20,000)
b
The difference between the return on plan assets and interest
income on plan assets is computed as follows:
Return on plan assets (actual income) – (5M x 12%) 600,000
Interest income on plan assets (expected income) - (5M x (500,000)
10%)
Gain 100,000
24. C
Solution:
Interest income on the beginning balance of FVPA 24,000
(480,000 x 5% x 12/12)
Interest income on the contributions made on July 1,
20x1 20,000
(800,000 x 5% x 6/12)
Reduction in interest income due to the benefits paid out
of (2,500)
the plan assets on Sept. 30, 20x1 (200,000 x 5% x 3/12)
Interest income on plan assets 41,500
25. A
Solution:
480,00
Jan. 1 0
Return on plan assets 200,00
(squeeze) 48,000 0 Benefits paid
800,00
Contributions to the fund 0
1,128,00
0 Dec. 31
26. D
Solution:
Interest income on plan assets (41,500)
Gain 6,500
27. C
Solution:
Interest income (actual) 800,000
Unrealized gains from fair value changes (actual) 400,000
Gross return on plan assets 1,200,000
105
Less: Costs of managing plan assets (80,000)
Taxes (1.2M x 10%) (120,000)
Return on plan assets 1,000,000
28. A
Solution:
Fair value of plan
assets
Jan. 1 4,000,000
Benefits
Return on plan assets 1,000,000 - paid
Contributions to the fund -
5,000,000 Dec. 31
29. A
Solution:
4,000,00
Fair value of plan assets, Jan. 1 0
Multiply by: 12%
480,00
Interest income on plan assets - Profit or loss 0
1,000,00
Return on plan assets 0
Gain - Other Comprehensive Income 520,000
30. D
Solution:
PV of defined benefit obligation, Jan. 1 4,000,000
Net defined benefit liability, Jan. 1 (deficit) (2,800,000)
There is a deficit as of the beginning of the period. Therefore, there is

no effect of the asset ceiling on the beginning balance of the net
defined benefit liability (asset).
The interest on the effect of the asset ceiling is computed as follows:

Effect of the asset ceiling - Jan. 1 -
Multiply by: Discount rate 10%
Interest on the effect of the asset ceiling -
31. A
Solution:
106
PV of defined benefit obligation, Dec. 31 3,000,000
Surplus – Dec. 31 1,000,000
1,000,00
Surplus – Dec. 31 0
Asset ceiling - PV of refunds from the fund 800,000
Net defined benefit asset, Dec. 31 - Lower amount 800,000
Surplus – Dec. 31 1,000,000

Effect of the asset ceiling - Dec. 31 200,000

200,00
Total change in the effect of the asset ceiling
0
Total change in the effect of the asset ceiling 200,000

Less: Interest on the effect of the asset ceiling -
200,00
Remeasurement recognized in OCI
0
32. A
Solution:
Fair value of plan assets, Jan. 1
2,800,000
PV of defined benefit obligation, Jan. 1
2,200,000
Surplus - Jan. 1
600,000
600,00
Surplus - Jan. 1 0
400,00
Asset ceiling - PV of refunds from the fund, Jan. 1 0
Net defined benefit asset, Jan. 1 - Lower 400,00
amount 0
Surplus - Jan. 1 600,000

200,00
Effect of the asset ceiling - Jan. 1
0
107
200,000
Interest on the effect of the asset ceiling
20,000
33. A
Solution:
3,200,00
PV of defined benefit obligation, Dec. 31
0
1,600,00
Surplus - Dec. 31
0
1,600,00
Surplus - Dec. 31 0
Net defined benefit asset, Dec. 31 - Lower
amount 800,000
1,600,00
Surplus - Dec. 31 0
Effect of the asset ceiling - Jan. 1 200,000


Interest on the effect of the asset ceiling (20,000)
Remeasurement recognized in OCI 580,000
34. B
Solution:
4,000,000
4,800,000
Net defined benefit liability - Jan. 1 (deficit)
(800,000)
35. A
108
Solution:
4,800,00
Jan. 1
0
Benefits 1,000,00 1,200,00
Current service cost
paid 0 0
120,000 Actuarial losses during the period
5,600,00
Dec. 31
0

Jan. 1 4,000,000
1,000,00 Benefits
0 paid
880,000
fund
4,200,00
Dec. 31
0
Net defined benefit liability - Dec. 31 (deficit) (1,400,000)
36. C
Solution:
Current service cost 1,200,000
Past service cost -
Net loss on settlement of plan during the year -
Net interest on the net defined benefit liability (asset) a 80,000
Actuarial (gain) loss 120,000
Difference between return and interest income on plan
80,000
asset b
Difference between change and interest on effect of
-
asset ceiling
a
The net interest on the net defined benefit liability (asset) is
Net defined benefit liability, Jan. 1
800,000
Net interest on the net defined benefit liability 80,000
109
b
The difference between return on plan assets and interest income
on plan assets is computed as follows:
320,00
Return on plan assets (actual income)
0
Interest income on plan assets (expected income) 400,000
(80,000
Loss
)
37. D
Solution:
2,800,00
0
2,200,00
0
600,00
Surplus - Jan. 1
0
400,00
Asset ceiling - PV of refunds from the fund, Jan. 1
0
400,00
Net defined benefit asset, Jan. 1 - Lower amount
0
38. C
Solution:
2,200,000 Jan. 1
Interest cost (2.2M x
220,000
10%)
240,00
0 Actuarial loss
3,200,00
Dec. 31
0
Fair value of plan

assets
2,800,00
Jan. 1
0
Benefits
paid
1,820,00
Contributions to the fund
0
110
4,800,000 Dec. 31

3,200,00
0
1,600,00
Surplus - Dec. 31
0
1,600,00
Surplus - Dec. 31
0
amount 800,000
39. B
Solution:
Service cost:
(a) Current service cost 960,000
(b) Past service cost 600,000
(c) (Gain) or loss on settlement -
1,560,000
Net interest on the net defined benefit liability (asset):
(280,000
(a) Interest income on plan assets (2,800,000 x 10%)
)
(b) Interest cost on the defined benefit obligation (2.2M x 220,000
10%)
a
(c) Interest on the effect of the asset ceiling 20,000
(40,000)

(a) Actuarial (gains) and losses 240,000
(320,000
interest
)
income on plan assets (600K actual – 280K expected)
asset 580,000
ceiling and interest on the effect of the asset ceiling b
a
111
Asset ceiling (PV of refunds from the fund) – Jan. 1 400,000
Interest on the effect of the asset ceiling 20,000
b
The difference between the change in the effect of the asset ceiling and
interest on the effect of the asset ceiling is computed as follows:
3,200,00
0
1,600,00
Surplus - Dec. 31
0
Surplus - Dec. 31 1,600,000

Asset ceiling (PV of refunds from the fund) – Dec. 31 800,000
Effect of the asset ceiling - Jan. 1 (see previous solution) 200,000

Change in the effect of asset ceiling – increase 600,000
Change in effect of the asset ceiling 600,000

Interest on the effect of the asset ceiling (see previous
(20,000)
solution)
Remeasurement recognized in OCI 580,000
40. A – see solution in the preceding problem
41. C
Solution:
8,000,000 Jan. 1
Benefits paid 200,000 1,200,000 Current service cost
Actuarial gain
a 720,000 Interest cost (8M x 9%)
640,000
Increase due to plan
1,600,000 amendment
10,680,00
Dec. 31
0
a
The actuarial gain pertains to the decrease in the obligation due to
changes in actuarial assumptions.
112
Jan. 1 7,200,000
b 200,00 Benefits
Return on plan assets 1,040,000
0 paid
8,040,00
Dec. 31
0
b
The adjusted return on plan assets is computed as follows:
1,120,00
Realized gains 0
Unrealized loss due to changes in fair values (80,000)
1,040,00

Net defined benefit liability - Dec. 31 (deficit)
(2,640,000)
42. B
Solution:
Past service cost (increase in obligation due to the 1,600,000
amendment)
c
Net interest on the net defined benefit liability (asset) 72,000
(640,000
Actuarial (gain) loss
)
Difference between return and interest income on plan (392,000
asset )
-
asset ceiling
(1,032,000
Defined benefit cost recognized in OCI
)
c
Fair value of plan assets, Jan. 1, 20x1 7,200,000
Present value of defined benefit obligation, Jan. 1,
8,000,000
20x1
Net defined benefit liability - Jan. 1 (deficit) 800,000
113
43. C – see solution in preceding problem
44. C
Solution:
Net defined benefit liability
- Jan. 1, 20x3
Contribution - 100,00
20x3 40,000 0 Defined benefit cost - 20x3
Contribution - 200,00 160,00
20x4 (squeeze) 0 0 Defined benefit cost - 20x4
Dec. 31, 20x4
(desired balance) 20,000
45. D
Solution:
Number of employees 20
Termination benefit per employee 160,000
3,200,00
Liability for termination benefits 0
Exercises
1. Solution: PV of defined benefit obligation
240,000 Jan. 1
Actuarial gain - Interest cost (240K x
decrease 24,000 10%)
in PV of DBO 20,000
204,00
Dec. 31 0
2. Solution:
240,000 Jan. 1
Benefits 100,00
paid 0 60,000 Current service cost (squeeze)
Interest cost (240,000 x 10%)
114
24,000
Actuarial loss - increase in PV of

20,000 PBO
244,00
Dec. 31 0
3. Solutions:
Requirement (a): Ultimate cost of the defined benefit plan
The future salary level on date of eligibility for retirement is
Current salary level as of January 1, 20x1 P6,000,000
Multiply by: Future value of P1 @ 3%, n= 4* 1.125509
Future salary level P6,753,054
*20x2 through 20x5, excluding 20x1 since salary increase starts in 20x2.
The retirement benefit entitlement of the employee for each year of

service he renders is computed as follows:
Future salary level 6,753,054
Multiply by: Retirement benefit as percentage of
6%
final salary
Retirement benefit entitlement for each year of
service 405,183
The total lump sum benefit to be received by the employee on

retirement date is computed as follows:
Retirement benefit entitlement for each year of
service 405,183
Multiply by: Number of service years 5
Total lump sum retirement benefit 2,025,915
Requirement (b): Current service cost

The current service cost is simply the present value of the
retirement benefit entitlement for each year of service. The
current services costs are computed as follows:
Retirement Present
value of P1
benefit @ 10%, "n =
entitlement per 4, 3, 2, 1, 0" Current
Date year of service service cost
a b c=axb
Jan. 1, 20x1
Dec. 31, 20x1 405,183 0.683013 276,745
115
Dec. 31, 20x2 405,183 0.751315 304,420
Dec. 31, 20x3 405,183 0.826446 334,862
Dec. 31, 20x4 405,183 0.909091 368,348
Dec. 31, 20x5 405,183 1 405,183
2,025,915
Requirement (c): Present value of defined benefit obligation

An amortization table is prepared in order to determine the following:
(a) current service cost, (b) interest cost, and (c) year-end balances of
projected benefit obligation.
Undis-
counte
d
retire- Accumu-
ment lated
benefit undis- Presen
entitle- counted t value PV of
ment retirement of P1 @ Curren defined
per benefit 10%, "n t Inte- benefit
year of entitle- = 4, 3, 2, service rest obliga-
Date service ment 1, 0" cost cost tion
b= e = f,
cumulativ beg.
e balance d=ax bal. x
a of (a) c c 10% f=bxc
1/1/x1 - - - - - -
12/31/x 0.68301
405,183 405,183 276,745 - 276,745
1 3
12/31/x 0.75131
405,183 810,366 304,420 27,675 608,840
2 5
12/31/x 0.82644 1,004,58
405,183 1,215,549 334,862 60,884
3 6 6
12/31/x 0.90909 100,45 1,473,39
405,183 1,620,732 368,348
4 1 9 3
12/31/x 147,33 2,025,91
405,183 2,025,915 1 405,183
5 9 5
The present value of the benefit obligation (PV of DBO) is disclosed

as follows:
20x1 20x2 20x3 20x4 20x5

PV of DBO, beg. - 276,745 608,840 1,004,586 1,473,393
Current service
276,745 304,420 334,862 368,348 405,183
cost
Interest cost - 27,675 60,884 100,459 147,339
Benefits paid ( - ) ( - ) ( - ) ( - ) ( - )
PV of DBO, end. 276,745 608,840 1,004,586 1,473,392 2,025,915
116
The ending balances of PBO may also be computed using T-
accounts as shown below:
PBO PBO
- 1/1/x1 276,745 1/1/x2
Bene Current Bene Current

-fits 276,74 service -fits 304,42 service
paid - 5 cost paid - 0 cost
Interest 27,67 Interest

- cost 5 cost
12/3 276,74 12/3 608,84

1/x1 5 1/x2 0
PBO PBO
608,840 1/1/x3 1,004,586 1/1/x4
Ben Curre
e- nt Ben Current
fits 334,86 servic e-fits service
paid - 2 e cost paid - 368,348 cost
60,88 Intere 100,45 Interest

4 st cost 9 cost
12/
31/ 1,004,58 12/3 1,473,39
x3 6 1/x4 2
PBO
1,473,3
92 1/1/x5
Benefits Current
paid - 405,183 service cost
147,33
9 Interest cost
2,025,91
12/31/x5 5
PBO
2,025,91
5 12/31/x5
Benefits 2,025,91
paid 5 - Current service cost
- Interest cost
12/31/x6 -
117
4. Solutions:
Case #1: Answer: 20,000 – amount determined using the plan’s
formula.
Case #2: Answer: 13,660.26 (20,000 x 0.683013)
Case #3: Answer: 49,586.76 [(20,000 x 3 years) x 0.826446]
5. Answer: 14,400 (60,000 per month x 2% x 12 months in a year) –

amount determined using the plan’s formula.
6. Answer: None – No benefit is attributed before the age of 25

because service before that does not lead to benefits (conditional
or unconditional). There is no obligating event. A benefit of
P20,000 shall be attributed from age 25 and subsequent years.
7. Answer: 200,000 (2M ÷ 10 years).
8. Answers:
Answer: Case #1
The attribution period is during the years where Mr. Juan is aged 35
to 55 – the period where Mr. Juan reaches the retirement age of 55
and renders 20 years of service. A benefit of P200,000 (4M ÷ 20
years) is attributed in each of those years.
No benefit is attributed to the periods before Mr. Juan reaches age 35

and after he reaches age 55. Mr. Juan’s retirement benefits do not
accrue until he reaches the age of 35.
Answer: Case #2
The attribution period is during the years where Ms. Jane is aged 45
to 65 – the period where Ms. Jane gets past the retirement age of 55
and renders 20 years of service. A benefit of P200,000 (4M ÷ 20
In this case, Ms. Jane’s retirement benefits starts to accrue

immediately in the year of employment.
Similar case shall apply to other employees employed between the

ages of 35 to 45.
Answer: Case #3
The attribution period is during the years where Mr. Lakay is aged 55
to 65. This is because service beyond the age of 65 does not lead to
118
material amount of further benefits. A benefit of P400,000 (4M ÷ 10
9. Solution:
Fair value of plan
assets
Jan. 1 240,000
Return on plan assets Benefits
(10% x 240,000) 24,000 100,000 paid

564,000 Dec. 31
10. Solutions:
Requirement (a): Net defined benefit liability (asset) – Jan. 1
Net defined benefit liability, Jan. 1 - deficit
Requirement (b): Net defined benefit liability (asset) – Dec. 31

2,400,000 Jan. 1
Benefits
100,000 600,000 Current service cost
paid
3,140,00
Dec. 31
0
Fair value of plan

assets
Jan. 1 2,000,000
Benefits
paid
60,000
fund
2,200,00
Dec. 31
0

Net defined benefit liability, Dec. 31 - deficit
119
11. Solutions:
Case #1:

500,000
contributions
Case #2:

300,000
contributions
12. Solution:
PV of defined benefit obligation, before amendment P 2,000,000
PV of defined benefit obligation, after amendment 3,000,000
Past service cost (Positive) – increase in obligation P 1,000,000
13. Solution:
(1) Service cost:
Past service cost (400K + 600K) 1,000,000
Loss on settlement 100,000
Net interest on the net defined benefit
(2) 40,000
liability
Defined benefit cost recognized in profit or
2,340,000
loss
Remeasurements of the net defined benefit
(3)
liability (asset):
Actuarial gain (40,000)
Difference between return on plan assets and
120,000
interest income on plan assets (360K - 240K)
Difference between the change in the effect of -
120
the asset ceiling and interest on the effect of
the asset ceiling
Defined benefit cost recognized in other
80,000
comprehensive income
 The net interest on the defined benefit liability (asset) is

Net defined benefit liability, Jan. 1 (deficit) - excess
400,000
of obligation over plan assets
Alternatively, the net interest on the defined benefit liability (asset)

may also be computed as follows:
Interest income on plan assets (3.6M x 10%) - credit (360,000)
Interest cost on the defined benefit obligation
400,000
(4M x 10%) - debit
Interest on the effect of the asset ceiling -
Net interest on the net defined benefit liability -
40,000
debit
14. Solutions:
Requirement (a): Interest income on plan assets
Interest income on the beginning balance of FVPA
(240K x 5% x 12/12) 12,000
Interest income on the contributions made on July 1,
20x1
(400K x 5% x 6/12) 10,000
Reduction in interest income due to the benefits paid out
of
the plan assets on Sept. 1, 20x1 (100K x 5% x 3/12) (1,250)
Requirement (b): Return on plan assets

Jan. 1 240,000
Return on plan assets
(squeeze) 24,000 100,000 Benefits paid
564,000 Dec. 31
121
Requirement (c): Remeasurement to the net defined benefit
obligation (asset)
Interest income on plan assets (20,750)
Gain 3,250
15. Solutions:
Requirement (a): Return on plan assets
Interest income (actual) 400,000
Unrealized gains from fair value changes (actual) 200,000
Gross return on plan assets 600,000
Less: Costs of managing plan assets (40,000)
Taxes (600K x 10%) (60,000)

Requirement (b): Fair value of plan assets – ending balance

Fair value of plan
assets
Jan. 1 2,000,000
Benefits
Return on plan assets 500,000 - paid
2,500,000 Dec. 31
Requirement (c): Amounts recognized in P/L and OCI

2,000,00
Fair value of plan assets, Jan. 1 0
Multiply by: 12%
240,00
Interest income on plan assets - Profit or loss 0
500,00
Interest income on plan assets - Profit or loss 240,000

260,00
Gain (loss) - Other comprehensive income 0
16. Solutions:
Requirement (a): Interest on the effect of the asset ceiling
122
Fair value of plan assets, Jan. 1 600,000
PV of defined benefit obligation, Jan. 1 2,000,000
(1,400,00
Net defined benefit liability, Jan. 1 (deficit)
0)
There is a deficit as of the beginning of the period. Therefore, there is

no effect of the asset ceiling on the beginning balance of the net
defined benefit liability (asset).

-
-
Requirement (b): Remeasurement – effect of asset ceiling

1,500,00
0
Surplus – Dec. 31 500,000
Surplus – Dec. 31 500,000

amount 400,000
500,00
Surplus 0


Total change in the effect of the asset 100,00
ceiling 0

Less: Interest on the effect of the asset ceiling -
Remeasurement recognized in other comprehensive 100,00
income 0
123
Reconciliation:
Interest on the effect of the asset ceiling - profit or
-
loss
Remeasurement - other comprehensive income 100,000
17. Solutions:
Requirement (a): Interest on the effect of the asset ceiling
1,400,000
1,100,000
Surplus - Jan. 1
300,000
300,00
Surplus - Jan. 1 0
200,00
Asset ceiling - PV of refunds from the fund, Jan. 1 0
Net defined benefit asset, Jan. 1 - Lower 200,00
amount 0
300,00
Surplus - Jan. 1 0
200,00
Asset ceiling - PV of refunds from the fund 0
100,00
0

100,000
10,000
Requirement (b): Remeasurement – effect of asset ceiling

1,600,00
0
Surplus - Dec. 31 800,000
800,00
Surplus - Dec. 31 0
124
400,00
Net defined benefit asset, Dec. 31 - Lower 400,00
amount 0
800,00
Surplus - Dec. 31 0
400,00
400,00
Effect of the asset ceiling - Dec. 31
0

100,000
Effect of the asset ceiling - Dec. 31
400,000
300,00
Total change in the effect of the asset ceiling
0

Remeasurement recognized in other
290,000
Reconciliation:
Interest on the effect of the asset ceiling - profit or 10,00
loss 0
Remeasurement - other comprehensive income 290,000
18. Solutions:
2,000,000
2,400,000
Net defined benefit liability - Jan. 1 (deficit)
(400,000)

2,400,00
Jan. 1
0
125
Benefits
paid
Actuarial losses during the
60,000 period
2,800,00
Dec. 31
0

Jan. 1 2,000,000
Benefits
paid
440,000
fund
2,100,00
Dec. 31
0
Fair value of plan assets, Dec. 31

2,100,000
2,800,000
(700,000)
Requirement (c): Defined benefit cost

Current service cost 600,000
Past service cost -
Net interest on the net defined benefit liability (asset) a 40,000
Defined benefit cost recognized in profit or loss 640,000
40,000
asset b
-
asset ceiling
100,000
Total defined benefit cost 740,000
a
Net defined benefit liability, Jan. 1
400,000
126
Alternatively the net interest on the net defined benefit liability (asset)
Interest income on plan assets (2M x 10%) - credit (200,000)
240,000
(2.4M x 10%) – debit
Interest on the effect of the asset ceiling - debit -
Net interest on the defined benefit liability - debit 40,000
b
160,00
Return on plan assets (actual income)
0
Interest income on plan assets (expected income) 200,000
(40,000
Gain (loss)
)
19. Solutions:
1,400,00
0
1,100,00
0
300,00
Surplus - Jan. 1
0
200,00
Asset ceiling - PV of refunds from the fund, Jan. 1
0
200,00
Net defined benefit asset, Jan. 1 - Lower amount
0

1,100,000 Jan. 1
Benefits
paid
Interest cost (1.1M x
110,000
10%)
120,00
0 Actuarial loss
Dec. 31 1,600,00
127
0
Fair value of plan

assets
Jan. 1 1,400,000
Benefits
paid
2,400,000 Dec. 31

1,600,00
0
800,00
Surplus - Dec. 31
0
400,00
Asset ceiling - PV of refunds from the fund
0
Net defined benefit asset, Dec. 31 - Lower 400,00
amount 0
Requirement (c): Defined benefit cost

Past service cost 300,000
Loss (gain) on settlement -
Net interest on the net defined benefit liability (asset) a (20,000)
Defined benefit cost recognized in profit or loss 760,000
(160,000)
assets - (gain) loss b
asset 290,000
ceiling – increase c
250,000
a
Net defined benefit asset, Jan. 1 - Lower amount 200,000
128
Net interest on the net defined benefit asset 20,000
Alternatively the net interest on the net defined benefit liability (asset)
140,00
Interest income on plan assets (1.4M x 10%) – credit
0
(110,000)
(1.1M x 10%) – debit
(10,000
Interest on the effect of the asset ceiling – debit *
)
Net interest on the net defined benefit asset –
20,000
credit
*The interest on the effect of the asset ceiling is computed as follows:

Asset ceiling - PV of refunds from the fund - Jan. 1 200,000

Interest on the effect of the asset ceiling 10,000
b
Return on plan assets (actual income) 300,000
Interest income on plan assets (expected income) (140,000)
Gain (loss) 160,000
c
The difference between change in effect of asset limit and interest
on effect of asset ceiling is computed as follows:
Effect of the asset ceiling - Dec. 31 – increase 400,000

Total change in the effect of the asset ceiling –
300,000
increase

Remeasurement recognized in other 290,000
129
20. Solutions:
Requirement (a): Net defined benefit liability (asset) – Dec. 31

4,000,000 Jan. 1
Actuarial gain 320,000 360,000 Interest cost (4M x 9%)
Increase due to plan
800,000 amendment
5,340,00
Dec. 31
0

Jan. 1 3,600,000
b 100,00 Benefits
0 paid
4,020,00
Dec. 31
0
b
The adjusted return on plan assets is computed as follows:
Return on plan assets, unadjusted 560,000
(40,000
Unrealized loss on changes in fair values )
Return on plan assets, adjusted 520,000

(1,320,00
0)
Requirement (b): Defined benefit cost

Past service cost 800,000
Net interest on the net defined benefit liability (asset)
c 36,000
Actuarial (gain) loss (320,000)
Difference between return and interest income on (196,000)
plan
130
asset
-
asset ceiling – increase
(516,000)
Total defined benefit cost 920,000
c
Fair value of plan assets, Jan. 1, 20x1 3,600,000
Present value of defined benefit obligation, Jan. 1,
4,000,000
20x1
Net defined benefit liability - Jan. 1 (deficit) 400,000
21. Solution:
Net defined benefit liability
- Jan. 1, 20x3
Contribution - Defined benefit cost -
20x3 20,000 50,000 20x3
Contribution - 100,00 Defined benefit cost -
20x4 (squeeze) 0 80,000 20x4
Dec. 31, 20x4
(desired balance) 10,000
22. Solution:
The termination benefit is P80,000. This is the amount that
ENVISAGE Co. has no other recourse but pay for terminating
employment regardless of whether the employees stay and render
service until the closure of the branch or they leave before closure.
The excess of P180,000 (260,000 – 80,000) is short-term employee
benefits because this is paid in exchange for employee service, rather
than for termination of employment.
Accordingly, ENVISAGE Co. shall recognize the following liability for

termination at the earlier of when the plan of termination is announced
and when the entity recognizes the restructuring costs associated
with the closure of the branch:
Number of employees 20
Termination benefit per employee 80,000
1,600,00
Liability for termination benefits 0
131
Chapter 28 – Leases (Part 1)
11
1. A 6. D B
.
12
2. E 7. C E
.
13
3. C 8. A C
.
14
4. C 9. B B
.
10 15
5. A C B
. .

11 16
1. B 6. A D C
. .
12 17
2. B 7. B B D
. .
13 18
3. A 8. B B A
. .
14 19
4. C 9. B D B
. .
10 15 20
5. A B A B
. . .
Solutions:
1. B
Solution:
Annual rent 100,000
PV of ordinary annuity of 1 @10%, n=10 6.15
PV of minimum lease payments 615,000
Fair value 700,000
Finance lease liability - Lower amount 615,000
2. B (100,000 x PV of ordinary annuity of 1 @10%, n=10) = 614,500
3. A
Solution:
Annual rent including executory costs 52,000
Real estate taxes (2,000)
Annual rent excluding executory costs 50,000
Multiply by: PV of annuity due @9%, n=9 6.5348
132
Finance lease liability before 1st payment 326,740
First payment due in advance (50,000)

Finance lease liability after 1st payment 276,740
*Answer choice is rounded-off
4. C
Solution:
Cash flows PV factors PV
Annual 10,00 PV annuity due @12%, 6.328
rent 0 n=10 2 63,282
10,00 0.322
BPO 0 PV of 1 @12%, n=10 0 3,220
66,50
2
5. A
Solution:
Cash flows PV factors PV
PV annuity due @9%,
Annual rent 13,000 n=5 4.2397 55,116
Guaranteed
RV 10,000 PV of 1 @9%, n=5 0.6499 6,499
Lease liability before 1st
payment 61,615
(13,000
First payment due immediately )
Lease liability after 1st payment 48,615
6. A (100,000 x PV ord. annuity @10%, n=5) = 379,000 (rounded-

off)
(379,000 x 10%) = 37,900
7. B
Solution:
Payment Int. Amortizatio Present
1/1/x7 112,500
12/31/x7 10,000 9,000 1,000 111,500
8. B (10,000 x PV ordinary annuity @10%, n=10) = 61,446. The

residual value is ignored because it is unguaranteed, (i.e.,
guaranteed by a third party rather than by the lessee or a party
related to the lessee)
133
9. B
Solution:
Payment Int. Amortizatio
Date s expense n Present value
12/31/x8 135,000
12/31/x8 20,000 - 20,000 115,000
12/31/x9 20,000 11,500 8,500
10. B (108,000 ÷ 12) = 9,000
11. D
Solution:
Cost 240,000
Residual value (fair value) (20,000)
Depreciable amount 220,000
Useful life 8
Depreciation expense 27,500
12. B
Solution:
First step: Place the given information on the amortization table.
Int. Amortizatio
Date Payments expense n Present value
12/31/x
9
1/1/x10 9,000 75,000
Second step: “Squeeze” for the requirement.

Payment Present
Date s This is theAmortization
Int. expense finance lease value
12/31/x obligation as of Dec. 31,
9 20x9, net of current portion.
1/1/x10 9,000 75,000
a
1/1/x11 9,000 7,500 1,500 73,500
a
(75,000 x 10%)
13. B
Solution:
Payment Int.
Date s expense Amortization Present value
12/31/x
8 316,500
134
12/31/x
8 50,000 - 50,000 266,500
12/31/x
9 50,000 26,650 23,350 243,150
14. D (758,000 x 10%) = 75,800
15. A
Solution:
Fair value (deemed equal to PV of MLP) 323,400
Divide by: PV annuity due @8%, n=5 4.3121
Annual lease payments 74,998
Multiply by: No. of payments in the lease 5
Gross investment in the lease 374,991
Less: Net investment in the lease (323,400)
Unearned interest income 51,591
*Answer choice is rounded-off
16. C (135,000 – 20,000) x 10% x 6/12 = 5,750
17. D
Solution:
PV = Cash flows x PV factor
7,596 = 2,000 x PV annuity due @ x%, n=5
First trial @ 12%:

(2,000 x PV annuity due @ 12%, n=5) = 7,596
(2,000 x 4.0373) = 7,596
8,075 is not equal to 7,596
We need a lower amount. Therefore, we will increase the rate. Let

us try 16%.
Second trial @ 16%:

(2,000 x PV annuity due @ 16%, n=5) = 7,596
(2,000 x 3.7982) = 7,596
7,596 is equal to 7,596. Therefore, the implicit interest rate is 16%.
18. A
Solution:
Sales 77,000
Cost of sales (60,000)
Gross profit 17,000
The finance lease is treated as a sales-type lease because the

problem states that the “collectibility of the remaining lease payments
135
is reasonably assured” and there are “no material cost uncertainties.”
Accordingly, profit from sale is recognized on initial recognition.
Furthermore, no interest income is recognized because there is no
passage of time yet. The lease commencement is on December 31,
20x6.
19. B
Solution:
Sales (PV of MLP) 3,300,000
Cost of sales (2,800,000)
Gross profit 500,000
20. B
Solution:
Sales 3,520,000
Cost of sales (2,800,000)
Gross profit 720,000
Interest revenue = (600,000 x PV of annuity due @10%, n=5) =

3,521,040 – 600,000 first payment = 2,921,040 x 10% x 6/12 =
146,052

1. B 11. A 21. C 31. D
2. A 12. D 22. B 32. A
3. D 13. D 23. A 33. B
4. B 14. A 24. B 34. A
5. B 15. A 25. C 35. D
6. A 16. A 26. A 36. C
7. C 17. C 27. B 37. A
8. C 18. C 28. D 38. A
9. A 19. B 29. B 39. B
10. D 20. D 30. A 40. C
Solution:
1. B (160,000 - 12,000) x PV of ordinary annuity @14%, n=10) =
771,985
2. A (771,985 + 80,000 initial direct cost) = 851,985
136
3. D (400,000 x PV of annuity due @10%, n=4) + (200,000 x PV of
1 @10%, n=4) = 1,531,343
4. B (1,531,343 – 400,000) x 10% = 113,134
5. B (800,000 x PV ordinary annuity @10%, n=5) + (80,000 x PV of

1 @10%, n=5) = 3,082,303
6. A
Solution:
Date Payments
expense n value
Jan. 1,
20x1 3,082,303
Dec. 31,
20x1 800,000 308,230 491,770 2,590,533
7. C (3,082,303 – 200,000 residual value*) ÷ 5 years = 576,461

*This represents the fair value of machine at the end of the lease
term.
8. C
Solution:
Date Payments
expense n value
Jan. 1,
20x1 3,082,303
Dec. 31,
20x1 800,000 308,230 491,770 2,590,533
Dec. 31,
20x2 800,000 259,053 540,947 2,049,586
The entry to record the purchase of the leased asset is as follows:

Jan. Machinery (balancing figure) 1,879,79
1, Finance lease liability 5
20x Accum. depreciation (576,461* x 2) 2,049,58
3 Machinery – leased asset 6 3,082,30
Cash in bank 1,152,92 3
2 2,000,00
0
* This represents the annual depreciation (see computation in previous problem)
9. A
Solution:
The present value of minimum lease payment allocated to the
building is computed as follows:
Annual rental 4,000,000
137
Multiply by: Fraction based on relative fair values 4/6
Portion of annual rental pertaining to building
element 2,666,667
PV of ordinary annuity of ₱1 @10%, n=10 6.14457
16,385,52
Present value of minimum lease payments
0
Fair value of building element on inception of the
lease 16,000,000
16,000,00
Initial cost of building – Lower amount 0
10. D None of the choices. If there is no reliable allocation basis, the

entire lease is classified as finance lease and both the land and
building are depreciated as a single asset.
11. A (400,000 x PV annuity due @10%, n=4) + (80,000 guaranteed

residual value x PV of 1 @10%, n=4) = 1,449,382
12. D
Solution:
Date Payments
expense n value
Jan. 1,
20x1 1,449,382
Jan. 1, 20x1 400,000 - 400,000 1,049,382
Jan. 1, 20x2 400,000 104,938 295,062 754,320
13. D
Solution:
Jan. Finance lease liability 80,000
1,
Accumulated dep. (1,449,382 – 80K) 1,369,38
20x
5 Building 2 1,449,38
2
14. A
Solution:
1,
Accumulated dep. (1,449,382 – 80K) 1,369,38
20x
5 Building 2 1,449,38
2
Jan. Loss on finance lease (80K – 20K) 60,000
1,
Cash in bank 60,000
20x
5
15. A
138
Solution:
Annual rent 400,000
Multiply by: Lease term 4
Gross investment - 1/1/20x1 (before first collection) 1,600,000
16. A
Solution:
Annual rent 400,000
Multiply by: PV of annuity due of ₱1 @10%, n=4 3.486852
Net investment in the lease - 1/1/20x1 (before first
collection) 1,394,741
17. C
Solution:
Gross investment before first collection on the lease 1,600,000
(1,394,741
Net investment before first collection on the lease
)
Unearned interest income - 1/1/20x1 (before first
collection) 205,259
18. C
Solution:
Gross investment in the lease is computed as follows:
Annual rent excluding executory costs (440,000 – 403,804
36,196)
Gross investment in the lease – Jan. 1, 20x1 1,615,216
19. B (403,804 x PV of ordinary annuity @10%, n=4) = 1,280,000
20. D (1,615,216 – 1,280,000) = 335,212
21. C
Solution:
A finance lease is generally classified as a direct financing lease
unless it is clear that it should be classified as a sales-type lease. The
information in the problem does not clearly state that the lease shall
be classified as a sales-type lease. Therefore, we will treat the lease
as a direct financing lease.
Under a direct financing lease, the net investment is equal to the

cost of the equipment plus any initial direct costs.
The net investment is computed as follows:

Cost of equipment 1,200,00
139
0
Initial direct cost 80,000
1,280,00
Net investment in the lease – Jan. 1, 20x1
0
The net investment computed above is also equal to the PV of

minimum lease payments discounted at the implicit interest rate.
We will be computing for the implicit interest rate using the “trial and
error” approach, with interpolation if needed.
The formula for the trial and error approach is:

Future cash flows x PV factor at x% = Present value
Where: x% = implicit interest rate
The implicit rate before adjustment for executory costs and initial
direct costs is 17.30%. This rate would result to a present value of
approximately ₱1,200,000. We need a present value of ₱1,280,000.
Therefore, the adjusted implicit rate should be less than 17.30%.
Also, initial direct costs reduce interest income recognized by the
lessor over the lease term. This means that the adjusted implicit rate
should be less than the unadjusted rate of 17.30%. With those
concepts in mind, we will first try a randomly selected rate less than
the unadjusted rate, say 10%, and adjust that rate depending on the
result.

 Future cash flows x PV factor at x% = Present value
 403,804* x PV of ordinary annuity @10%, n=4 = 1,280,000
 (403,804 x 3.169865) = 1,280,004 approximates 1,280,000
The amount derived using 10% approximates the net investment.

Therefore, 10% is the implicit rate in the lease.
22. B
Solution:
We will “squeeze” for the amount of annual rental from the formula of
net investment.
Annual rent excluding executory costs xx

Multiply by: PV of ordinary annuity of ₱1 xx
Net investment in the lease xx
The finance lease is assumed to be a direct financing lease.

Therefore, net investment is equal to the cost of the equipment plus
any initial direct costs.
140
1,200,00
Cost of equipment
0
1,280,00
0
Annual rent excluding executory costs 403,803 (squeeze)

Multiply by: PV of ord. annuity of ₱1 @10%,
3.169865
n=4
1,280,00 (start)
Net investment in the lease
0
Annual rent excluding executory costs

403,803
Add back: Annual executory costs charged to
lessee 36,196
Annual rent including executory costs
439,999*
* Answer choice is rounded-off
23. A
(440,000 – 36,196) = 403,804 x PV ordinary annuity @10%, n=4 =
1,280,000
Amortization table:
Date Collections
income n value
Jan. 1, 20x1 1,280,000
Dec. 31, 20x1 403,804 128,000 275,804 1,004,196
Dec. 31, 20x2 403,804 100,420 303,384 700,812
Jan. Cash on hand 600,000

1,
Loss on sale (squeeze) 100,812
20x
3 Finance lease receivable - net 700,812
24. B (400,000 x 4 years) = 1,600,000
25. C (400,000 x PV annuity due @10%, n=4) = 1,394,741
26. A (1,600,000 – 1,394,741) = 205,259
27. B (1,394,741 – 1,200,000 = 194,741
28. D (194,741 – 80,000 initial direct costs) = 114,741
141
29. B (400,000 x 4) + 80,000 = 1,680,000
30. A (400,000 x PV ordinary annuity @10%, n=4) + (80,000 X PV of

1 @10%, n=4) = (1,267,946 + 54,641) = 1,322,587
31. D (1,680,000 - 1,322,587) = 357,413
32. A
Solution:
We will “squeeze” for the amount of annual rental from the formula of
net investment.
Net (Annual rental x PV (Residual value

= +
investment ordinary annuity of 1 x PV of 1
Since the lease is classified as direct financing lease, the net

investment must be equal to the cost of the equipment plus initial
direct costs, if any.
1,322,58
Net investment (equal to cost of equipment) 8
(Annual rental x PV
1,322,58 (80,000 x PV of 1
= ordinary annuity of 1 @10%, +
8 @ 10%, n=4)
n=4)
1,322,58 (Annual rental x
= + (80,000 x 0.683013)
8 3.169865)
1,322,58 (Annual rental x
= + 54,641
8 3.169865)
= 1,322,588 - 54,641
Annual rental
3.169865
=
Annual rental 400,000
33. B (400,000 x 4 years) + 80,000 = 1,680,000
34. A (400,000 x PV ordinary annuity @10%, n=4) + (80,000 x PV of

1 @10%, n=4) = (1,267,946 + 54,641) = 1,322,587
35. D (1,680,000 - 1,322,587) = 357,413
36. C
142
Solution:
Guaranteed residual value Unguaranteed residual value
Sales (PV of annual rentals) 1,267,946 Sales (PV of annual rentals) 1,267,946
Add: PV of guaranteed Cost of sales 1,200,000
residual value 54,641 Less: PV of unguaranteed
Adjusted sales residual value ( 54,641)
1,322,587 Adjusted cost of sales (1,145,359)
Cost of sales (1,200,000) Gross profit 122,587
Gross profit
122,587
37. A (See solution above)
38. A (See solution above)
39. B (400,000 x PV ordinary annuity @10%, n=4) = 1,267,946
40. C (400,000 x PV ordinary annuity @10%, n=4) = 1,267,946 vs.

1,240,000 fair value; sales = 1,240,000 the lower amount
Exercises
1. Solution:
Rental payments excluding executory costs (80,000 – 6,000) 74,000
Multiply by: PV of an ordinary annuity of P1 @14%, n=10 5.216116
Present value of minimum lease payments 385,993
The initial cost of the leased asset is determined as follows:

Present value of minimum lease payments
(see computation above) 385,993
Fair value of leased property on inception of the lease 440,000
Present value of minimum lease payments - Lower 385,993

Initial direct costs 40,000
Initial cost of leased property 425,993
The entry to record the finance lease at the commencement of the

lease is:
Jan. Machinery 425,99
1, Finance lease liability 3 385,99
20x Cash in bank 3
1 (or accrued payable if not yet paid) 40,000
2. Solution:
The present value of minimum lease payments is computed as
follows:
Minimum lease payments PV factors @10%, n=4 PV of
143
MLP
200,00 PV of an annuity due
Annual rent 0 of P1 3.486852 697,370
Bargain purchase 100,00 0.68301 68,30
option 0 PV of P1 3 1
765,67
2
Amortization table:
Date
s expense n value
Jan. 1,
765,672
20x1
Jan. 1,
200,000 0 200,000 565,672
20x1
Jan. 1,
200,000 56,567 143,433 422,239
20x2
Jan. 1,
200,000 42,224 157,776 264,463
20x3
Jan. 1,
200,000 26,446 173,554 90,909
20x4
Jan. 1,
100,000 9,091 90,909 0
20x5
The pertinent entries in 20x1 and 20x2 are as follows:

Jan. 1, Equipment 765,672
20x1 Finance lease liability 765,672
Jan. 1, Finance lease liability 200,000
20x1 to accrue interest incurred
during the year
Dec. Depreciation expense 143,134
31, [(765,672 – 50,000) ÷ 5 yrs.]
20x1 Accumulated depreciation 143,134
to recognize depreciation
expense
20x2
31, Accumulated depreciation 143,134
20x2
The entry on January 1, 20x5 to record the exercise of the BPO is:
144
3. Solution:
The present value of minimum lease payments is computed as
follows:
Minimum lease
payments PV factors @10%, n=5 PV of MLP
PV of ordinary annuity
Annual rent 400,000 of P1 3.790787 1,516,315
Bargain
purchase
option 40,000 PV of P1 0.620921 24,837
1,514,15
2

Date
s expense n value
Jan. 1, 20x1 1,541,152
Dec. 31,
400,000 154,115 245,885 1,295,267
20x1
Dec. 31,
400,000 129,527 270,473 1,024,793
20x2
Dec. 31,
400,000 102,479 297,521 727,273
20x3
Dec. 31,
400,000 72,727 327,273 400,000
20x4
Dec. 31,
400,000 40,000 360,000 40,000
20x5

1, Finance lease liability 2 1,541,15
20x1 2
31, Finance lease liability 129,527
31, [(1,541,152 – 100,000) ÷ 5 yrs.]
The entry on December 31, 20x5 to record final lease payment and
exercise of BPO are:
Cash in bank 0 400,000
to record final lease payment
Dec. 31, Finance lease liability 40,000
145
to record exercise of BPO
4. Solution:
Date
s expense n value
Jan. 1, 20x1 1,541,152
Dec. 31,
400,000 154,115 245,885 1,295,267
20x1
Dec. 31,
400,000 129,527 270,473 1,024,793
20x2
Dec. 31,
400,000 102,479 297,521 727,273
20x3
Dec. 31,
400,000 72,727 327,273 400,000
20x4
Dec. 31,
400,000 40,000 360,000 40,000
20x5
Jan. Machinery (balancing figure) 939,899

1, Finance lease liability 1,024,79
20x3 Accumulated depreciation 3
(P288,230 x 2) 576,460
Machinery – leased asset 1,541,15
Cash in bank 2
1,000,00
0
5. Solution:
The present value of minimum lease payment allocated to the
building is computed as follows:
Multiply by: Fraction based on relative fair values 8/12
Portion of annual rental pertaining to building element 1,333,333
Present value of minimum lease payments 8,192,758
Fair value of building element on inception of the lease 8,000,000
Initial cost of building – Lower amount 8,000,000
The entry to record the lease is:

Jan. Building 8,000,00
1, Finance lease liability 0 8,000,00
20x1 0
6. Solution:
Present value of minimum lease payments 12,289,140
146
Jan. 1, Land and building 12,289,14
20x1
Finance lease liability 0 12,289,14
0
7. Solution:
PV of
Minimum lease payments PV factors @10%, n=4 MLP
PV of an
200,00 annuity due of
Annual rent 0 P1 3.486852 697,370
Guaranteed
residual value 40,000 PV of P1 0.683013 27,321
724,691

Date
s expense n value
Jan. 1,
724,691
20x1
Jan. 1,
200,000 0 200,000 524,691
20x1
Jan. 1,
200,000 52,469 147,531 377,160
20x2
Jan. 1,
200,000 37,716 162,284 214,876
20x3
Jan. 1,
200,000 21,488 178,512 36,364
20x4
Jan. 1,
40,000 3,636 36,364 0
20x5
The entries in 20x1 are:

Jan. 1, Building 724,69
20x1 Finance lease liability 1 724,69
1
20x1 Cash in bank 0 200,00
0
31,
20x1
to record accrued interest
31, [(724,691 – 40,000) ÷ 4 yrs.] 3
20x1
Accumulated depreciation 171,17
3
Requirement (a):
The entry on December 31, 20x4 to record interest is:
147
The entry on January 1, 20x5 to record the return of the leased asset
to the lessor is:
(724,691 – 40,000) 1
Building 724,69
1
Requirement (b):
The entry on December 31, 20x4 to record interest is:
20x4
The entries on January 1, 20x5 to record the return of the leased

asset to the lessor is:
1, Accumulated depreciation 684,69
20x5 (724,691 – 40,000) 1
Building 724,69
1
Jan. Loss on finance lease (40,000 – 30,000
1, 10,000) 30,000
20x5
Cash in bank
8. Solutions:
Requirement (a):
Annual rent P 200,000
Multiply by lease term 4
Gross investment in the lease – Jan. 1, 20x1
(before first collection) P 800,000
Requirement (b):
Multiply by: PV of annuity due of P1 @10%, n=4 3.486852
Requirement (c):
Gross investment before first collection on the lease P 800,000
Net investment before first collection on the lease ( 697370)
Unearned interest income – Jan. 1, 20x1 P 102,630
9. Solutions:
148
Requirement (a) – Gross investment on Jan. 1, 20x1
Gross investment in the lease is computed as follows:
Annual rent excluding executory costs (220,000 – 18,098) P 201,902
Gross investment in the lease – Jan. 1, 20x1 P 807,608
Requirement (b) – Net investment on Jan. 1, 20x1

Net investment in the lease is computed as follows:
Annual rent excluding executory costs (220,000 – 18,098) P 201,902
Net investment in the lease – Jan. 1, 20x1 P 640,000
Net investment in the lease may also be computed as follows:

Cost of equipment P 600,000
Requirement (c) – Unearned interest income on Jan. 1, 20x1

Unearned interest income is computed as follows:
Gross investment in the lease P807,608
Net investment in the lease ( 640,000)
Unearned interest income – Jan. 1, 20x1 P167,608
10. Solution:
Net investment in the lease – Jan. 1, 20x1 P640,000
Using the “trial and error” approach, the implicit rate in the lease is
10%.
11. Solution:
Net investment in the lease P 640,000

Divide by: PV of ordinary annuity of P1 @10%, n=4 3.169865
Annual rent excluding executory costs P 201,901
Annual rent excluding executory costs P 201,901

Annual executory costs charged to lessee 18,098
Annual rent including executory costs P 220,000*
149
*rounded-off to nearest ten-thousandths
12. Solution:
The amortization table is prepared as follows:
Date Collections
income n value
Jan. 1, 20x1 640,000
Dec. 31, 20x1 201,902 64,001 137,901 502,099
Dec. 31, 20x2 201,902 50,211 151,691 350,408
Dec. 31, 20x3 201,902 35,041 166,861 183,547
Dec. 31, 20x4 201,902 18,355 183,547 0
The entry to record the sale on January 1, 20x3 is:

1, Unearned interest (403,804 – 350,408) 53,396
20x Loss on sale of leased equipment 50,408
3 (squeeze)
Finance lease receivable 403,804
(201,902 x 2)
13. Solutions:
Requirement (a) – Gross investment on Jan. 1, 20x1
Gross investment in the lease – Jan. 1, 20x1
Requirement (b) – Net investment on Jan. 1, 20x1

Multiply by: PV of an annuity due of P1 @10%, n=4 3.486852
Requirement (c) – Total interest income to be recognized over

lease term
Gross investment P 800,000
Net investment ( 697,370)
Unearned interest income – Jan. 1, 20x1
Requirement (d) – Gross profit from sale

Sales (equal to net investment) P 697,370
Cost of sales (cost of equipment) ( 600,000)
Gross profit P 97,370
Initial direct costs charged as expense ( 40,000)
150
Net profit from sale P 57,370
14. Solution:
Requirement (a) – Gross investment
Total rentals (200K x 4) 800,000 Total rentals (200K x 4)
Guaranteed residual value 40,000 (Total undiscounted MLP) 800,000
Gross investment in the Unguaranteed residual
lease 840,000 value 40,000
(Total undiscounted MLP) Gross investment in the
lease P840,000
(MLP + Unguaranteed Residual
Value)
Requirement (b) – Net investment

Net investment if residual value is guaranteed is computed as
follows:
PV factors @10%, PV of
Minimum lease payments n=4 MLP
633,97
Annual rent 200,000 3.169865 3
Guaranteed residual
value 40,000 0.683013 27,321
661,29
Net investment in the lease (PV of gross investment) 4
Net investment if residual value is unguaranteed is computed as

follows:
Net
PV factors investment
Minimum lease payments @10%, n=4 in the lease
Annual rent (MLP) 200,000 3.169865 633,973
Unguaranteed residual
value 40,000 0.683013 27,321
Net investment in the lease (PV of gross investment) 661,294
Requirement (c) – Unearned interest income

Total interest income recognized over the lease term is computed as
follows:
Gross investment in the Gross investment in the
lease 840,000 lease 840,000
Net investment in the Net investment in the
lease (661,294) lease (661,294)
Unearned interest income Unearned interest income P178,706
P178,706
151
Amortization table is prepared to provide basis for subsequent
entries.
Collection Interest Amortizatio Present
Date
s income n value
Jan. 1, 20x1 661,294
Dec. 31,
200,000 66,129 133,871 527,423
20x1
Dec. 31,
200,000 52,742 147,258 380,166
20x2
Dec. 31,
200,000 38,017 161,983 218,182
20x3
Dec. 31,
200,000 21,818 178,182 40,000
20x4
Requirement (d):
Case A:
Dec. 31, 20x4 Dec. 31, 20x4
Cash on hand 200,000 Cash on hand 200,000
Equipment 40,000 Equipment 40,000
Unearned interest Unearned interest
income 21,818 income 21,818
Finance lease Finance lease
receivable 240,000 receivable 240,000
Interest income 21,818 Interest income 21,818
Case B:
Dec. 31, 20x4 Dec. 31, 20x4
Cash on hand Cash on hand 200,000
(200K + 30K) 230,000 Equipment 10,000
Equipment 10,000 Impairment loss 30,000
Interest income 21,818 Interest income 21,818
15. Solution:
661,29
Cost of equipment - net investment (a) 4
Guaranteed residual value 40,000

0.68301
Multiply by: PV of P1 @10%, n=4 3
PV of guaranteed residual value (b) 27,320
152
Amount recovered by lessor through lease payments
(a - b) 633,974
3.16986
Divide by: PV of ordinary annuity of P1 @10%, n=4 5
Annual rent 200,000
16. Solutions:
Requirement (a) – Gross investment
Total rentals (200K x 4) 800,000 Total rentals (200K x 4)
Guaranteed residual (Total undiscounted MLP) 800,000
value 40,000 Unguaranteed residual
Gross investment in the value 40,000
lease 840,000 Gross investment in the
(Total undiscounted MLP) lease 840,000
(MLP + Unguaranteed Residual
Value)
Requirement (b) – Net investment

Net investment if residual value is guaranteed is computed as
follows:
PV factors
Minimum lease payments @10%, n=4 PV of MLP
Annual rent 200,000 3.169865 633,974
Guaranteed residual
value 40,000 0.683013 27,320
Net investment in the lease (PV of gross 661,29
investment) 4
Net investment if residual value is unguaranteed is computed as

follows:
Net
PV factors @10%, investment
n=4 in the lease
200,00
Annual rent (MLP) 0 3.169865 633,974
Unguaranteed residual
value 20,000 0.683013 27,320
Net investment in the lease (PV of gross
investment) 661,294
Requirement (c):
Total interest income recognized over the lease term is computed as
follows:
Gross investment in the Gross investment in the
lease 840,000 lease 420,000
153
Net investment in the lease(661,294) Net investment in the lease (330,647)
Unearned interest income 178,706 Unearned interest income 178,706
Requirement (d):
Sales Sales
(PV of annual rentals) 633,974 (PV of annual rentals) 633,974
Add: PV of guaranteed Cost of sales 600,000
residual value 27,320 Less: PV of unguaranteed
Adjusted sales 661,294
Cost of sales ( 600,000)
residual value ( 27,320)
Gross profit 61,294 Adjusted cost of sales (572,680)
Gross profit 61,294
Requirement (e):
The entry to record the sales-type lease on January 1, 20x1 is:
Jan. 1, 20x1 Jan. 1, 20x1
Cost of sales 600,000 Cost of sales 572,680
Sales 661,294 Sales 633,974
Inventory 600,000 Inventory 600,000
17. Solution:
PV of ordinary annuity of P1 @ 10%, n=4 3.169865
Net investment P 633,973
18. Solution:
PV of ordinary annuity of P1 @ 10%, n=4 3.169865
Net investment P 633,973
Fair value of equipment P 620,000
Answer: Sales is recognized at P3
154
Chapter 29 – Leases (Part 2)
1. A 6. B 11. B
2. B 7. D 12. D
3. C 8. D 13. C
4. B 9. A 14. C
5. B 10. C 15. C

1. B 6. A
2. C 7. C
3. B 8. B
4. C 9. A
10
5. C A
.
Solutions:
1. B {10,000 + [(30,000 ÷ 5 years) x 1/12]} = 10,500
2. C [90,000 + (50,000 ÷ 5 years)] = 100,000
3. B
Solution:
Straight line rent income per year = 36,000 ÷ 3 = 12,000
Rent income per year 12,000

Multiply by: 2
Total rent income to date (July 1, 20x6 to June 30,
20x8) 24,000
Less: Total rent collections to date (6,000 + 9,000) (15,000)
Rent receivable as of June 30, 20x8 9,000
4. C
Solution:
Annual rent 96,000
Contingent rent [(600,000 - 500,000) x 5%] 5,000

Amortization of lease bonus (24,000 ÷ 10) 2,40
155
0
103,40
Rent expense 0
5. C
Solution:
Rent for the first year (8,000 x 6/12) 4,000
Rent for the subsequent years (12,500 x 4) 50,000
Total collection on rentals 54,000

Divide by: 5
Annual rent income 10,800
6. A
Solution:
Lease term in years 5
Multiply by: No. of months in a year 12
Lease term in months 60
Nine months free rent (9)

Total 51
Multiply by: Monthly rental 1,000
Total rental payments on the lease 51,000

Divide by: Lease term in years 5
Annual rent expense (July 1 to June 30) 10,200
7. C
Solution:
Useful life of leasehold improvements 8 yrs.
Remaining lease term (Jan. 20x9 to Dec. 31, 2x14) 6 yrs.
Shorter 6 yrs.
Carrying amount of leasehold improvement = 48,000 x 5.5/6 = 44,000
8. B
Solution:
Sale price 150,000
Carrying amount (100,000)
Deferred gain - 1/1/x7 50,000
156
Multiply by: 9/10
Deferred gain - 12/31/x7 45,000
9. A
Solution:
The leaseback is an operating lease and the sale was established at
fair value. Accordingly, any gain or loss is recognized immediately.
10. A (See explanation in the previous problem)

1. B 6. D 11. C 16. A
2. B 7. C 12. A 17. B
3. B 8. D 13. A
4. B 9. D 14. A
5. C 10. B 15. B
Solutions:
1. B (400,000 – 20,000) + (80,000 ÷ 5 years) = 396,000
2. B (400,000 – 20,000) + (80,000 ÷ 5 years) = 396,000
3. B (60,000 x PV of 1 @10%, n=5) = 37,255 x 110% = 40,981
Unequal rental payments

Use the following information for the next three questions:
On January 1, 20x1, FLAGITOUS Co. leased an office space from
VICIOUS, Inc. Payments on the lease will be made as follows:
Year Rental payment
Dec. 31, 20x1 400,000
Dec. 31, 20x2 480,000
Dec. 31, 20x3 520,000
1,400,000
 As an inducement to enter to the lease, VICIOUS granted

FLAGITOUS the first six months of the lease rent-free.
 Additional rent (contingent rent) of 10% is to be paid for any
excess of sales of FLAGITOUS over ₱4,000,000. FLAGITOUS’s
sales for 20x1, 20x2, and 20x3 are ₱1,800,000, ₱4,000,000, and
₱6,000,000, respectively.
157
4. B (400,000 x 6/12) + 480,000 + 520,000 = 1,200,000 ÷ 3 years =
400,000 annual rent income/expense – (400,000 x 6/12 collection
in 20x1) = 200,000
5. C (400,000 annual rent expense x 2 years) – (400,000 x 6/12

collection in 20x1 + 480,000 collection in 20x2) = 120,000
6. D (400,000 annual rent expense) + [(6M – 4M) x 10%] = 600,000
7. C
Solution:
Rent income on straight line – July to Dec. 20x1 (800K x
6/12) 400,000
Depreciation expense on equipment [(4M – 480K) ÷ 10
years] (352,000)
Amortization of initial direct cost [(80,000 ÷ 5 years) x 6/12] (8,000)
Insurance expense (4,000)
Rent income net of expenses – 20x1 36,000
8. D (4,000,000 historical cost of equipment – 352,000 accumulated

depreciation) + (80,000 initial direct cost – 8,000 accumulated
amortization) = 3,720,000
9. D
10. B [1,267,948 sale price – (2M – 960K)] = 227,948 deferred gain
11. C [1,720,000 sale price – (4M – 2.2M)] = -80,000 outright loss
12. A (1,280,000 sale price – 1,040,000* carrying amount) = 240,000

outright gain
*(2,000,000 cost – 960,000 accumulated depreciation) = 1,040,000
13. A (1,280,000 sale price – 1,040,000 carrying amount) = 240,000

outright gain
14. A (1,280,000 sale price – 1,600,000 carrying amount) = -320,000

outright loss
15. B (1,280,000 sale price – 1,600,000 carrying amount) = -320,000

deferred temporary loss
16. A (1,280,000 sale price – 1,200,000 fair value) = 80,000 deferred

gain; (1,200,000 fair value – 1,040,000) = 160,000 outright gain
158
17. B (1,280,000 sale price – 960,000 fair value) = 320,000 deferred
gain; (960,000 fair value – 1,040,000) = -80,000 outright loss
Exercises
1. Solutions:
Annual rent expense (rent income) is computed using the straight line
method as follows:
Annual rent excluding executory costs (200,000 – 10,000) 190,000
Multiplied by: Lease term 5
Total rentals excluding executory costs 950,000
Lease bonus 40,000
Total payments on lease excluding executory costs 990,000
Divide by: Lease term 5
Annual rent expense (rent income) 198,000
The security deposit is discounted as follows:

PV of P1 @10%, n=5 0.620921
Present value of security deposit 18,628
The entries in the books of the lessee and lessor are as follows:
Books of REMNANT Co. – Books of REMAINDER Co. -
Lessee Lessor
Jan. 1, 20x1 Jan. 1, 20x1
Prepaid rent 40,000 Cash on hand 40,000
Cash in bank Unearned rent
40,000 40,000
to record payment of lease to record receipt of lease
bonus bonus
Jan. 1, 20x1 Jan. 1, 20x1

Security deposit Cash on hand 30,000
receivable 30,000 Discount on security
Unrealized loss – deposit payable 11,372
“Day 1” difference11,372 Security deposit
Cash in bank payable
15,000 30,000
Unearned interest Unrealized gain
income – “Day 1” difference
11,372 11,372
to record payment for to record receipt of
security deposit security deposit
Dec. 31, 20x1 Dec. 31, 20x1

Rent expense 198,000 Cash on hand 200,000
Insurance expense 10,000 Unearned rent 8,000
159
(executory cost) (amortization of lease bonus)
Cash in bank Rent income
200,000 198,000
Prepaid rent Insurance expense
8,000 10,000
(amortization of lease bonus) to record collection of rent
(40,000 ÷ 5 years) including reimbursement for
to record payment of rent executory costs
including executory costs
Dec. 31, 20x1 Dec. 31, 20x1

Unearned interest Interest expense
income 1,862.80 (18,628 x 10%) 1,862.80
Interest income Discount on security
1,862.80 deposit payable
(18,628 x 10%) 1,862.80
to record amortization of to record amortization of
discount on security deposit discount on security deposit
2. Solutions:
Annual rent expense (and rent income) is computed using the straight
line method as follows:
Total rentals P 700,000
First six-month rent-free (100,000 x 6/12) ( 100,000)
Adjusted total rentals 600,000
Divide by: Lease term 3
Annual rent expense (income) P200,000
The entries are:

Books of lessee – DEMENTED Books of lessor – INSANE, Inc.
Co.
Jan. 1, 20x1 Jan. 1, 20x1
No entry No entry
Dec. 31, 20x1 Dec. 31, 20x1
Cash in bank 100,000 Rent receivable 100,000
Rent payable 100,000 Rent income 200,000
Dec. 31, 20x2 Dec. 31, 20x2

Dec. 31, 20x3 Dec. 31, 20x3

160
Dec. 31, 20x3 Dec. 31, 20x3

Rent expense 100,000 Rent receivable 100,000
[10% x (3M – 2M)] Rent income 100,000
Rent payable 100,000 [10% x (3M – 2M)]
to record contingent rent to record contingent rent receivable
payable
3. Solutions:
Requirement (a): Net rental income in 20x1
Rent income on straight line – July to Dec. 20x1 (400K x 6/12) P200,000
Depreciation expense on equipment [(2M – 240K) ÷ 10 years] (176,000)
Amortization of initial direct cost [(20,000 ÷ 5 years) x 6/12] ( 4,000)
Insurance expense ( 2,000)
Rent income net of expenses – 20x1 P
18,000
Requirement (b): Carrying amount of leased asset as of Dec. 31,

20x1
Cost of equipment P2,000,000
Accumulated depreciation – equipment ( 176,000)
Total 1,824,000
Deferred initial direct cost (40,000 x 4.5/5) or (40,000 – 4,000) 36,000
Carrying amount of equipment – Dec. 31, 20x1 P1,860,000
4. Solutions:
The leaseback is treated as finance lease since the “major part of
economic life or ‘75%’” criterion is met (i.e., 4/5 = 80%).
The gain or loss on sale is computed as follows:

Sales price (usually equal to present value of 633,974
rentals)
Carrying amount of equipment (1M – 480,000) (520,000
)
Gain on sale 113,97
4
Finance lease liability and finance lease receivable are computed as

follows:
RUSTIC Co. – Seller/ Lessee RURAL Inc. - Buyer/Lessor
Annual rent 200,000 Gross investment
PV of ordinary annuity of (200K x 4) 800,000
P1 @10%, n=4 3.169865
PV of Minimum lease Annual rent 200,000
161
payments 633,973 PV of ordinary annuity of
P1 @10%, n=4 3.16987
Net investment 633,974
Gross investment 800,000

Net investment (633,974)
Unearned interest
income 166,026
The entries are:

Books of seller/lessee Books of buyer/lessor
(RUSTIC Co.) (RURAL, Inc.)
Dec. 31, 20x1 Dec. 31, 20x1
Cash on hand 633,974 Equipment 633,974
Accumulated Cash in bank 633,974
depreciation 480,000 to record the purchase of
Equipment 1,000,000 equipment
Deferred gain 113,974
to record the sale of equipment
Dec. 31, 20x1 Dec. 31, 20x1
Equipment 633,974 Finance lease
Finance lease liability 633,974 receivable 800,000
to record the finance leaseback Equipment 633,974
Unearned interest
income 166,026
to record the finance
leaseback
Dec. 31, 20x2 Dec. 31, 20x2

Interest expense 63,397 Cash on hand 200,000
(633,974 x 10%) Unearned interest
Finance lease liability 136,603 income 63,397
Cash in bank 200,000 Finance lease
to record first rental payment receivable 200,000
Interest income 63,397
(633,974 x 10%)
to record first rental collection
Dec. 31, 20x2

Deferred gain
(113,974 ÷ 4) 28,494 No entry
Gain on sale and
leaseback 28,494
to record amortization of
deferred gain
5. Solution:
The leaseback is treated as finance lease since the “major part of
economic life or ‘75%’” criterion is met (i.e., 10/11 = 90.90%).
162
The entry in INORDINATE’s books on January 1, 20x1 to record the
sale is:
1, Accumulated depreciation 1,100,00
20x1 Loss on sale 0
Equipment 40,000 2,000,00
to record sale of equipment 0
Jan. Equipment 930,000

1, Finance lease liability 930,000
20x1 to record finance leaseback
6. Solutions:
Requirement (a):
Sale price 640,000
)
Gain on sale recognized immediately 120,000
Requirement (b):
Sale price 640,000
Carrying amount of equipment (500,000 – 240,000) (520,000)
Gain on sale recognized immediately 120,000
Requirement (c):
Sale price 640,000
Carrying amount of equipment (800,000)
Loss on sale recognized immediately (160,000)
Requirement (d):
Sale price 640,000
Carrying amount of equipment (800,000)
(Temporary) Loss on sale – deferred (160,000)
Requirement (e):
Sale price 640,000
Fair value of equipment (600,000
)
Gain on sale to be deferred and amortized over 40,000
lease term
Fair value of equipment 600,000
Gain on sale to be recognized immediately 80,000
163
Requirement (f):
Sale price 640,000
Fair value of equipment (600,000)
Gain on sale to be deferred and amortized over 40,000
lease term
Fair value of equipment 480,000
Impairment loss to be recognized immediately (40,000)
164
Chapter 30 – Income Taxes
1. B 6. D
2. B 7. D
3. A 8. C
4. D 9. A
5. C 10. B

11 16
1. A 6. C D C
. .
12 17
2. A 7. B C D
. .
13 18
3. B 8. C C D
. .
14 19
4. C 9. A A A
. .
10 15 20
5. C C D D
. . .
Solutions:
1. A
Solution:
Multiply by
Description of items Tax rate
Description of items
Pretax income 800,000
Permanent differences:
Less: Non-taxable
income
Gain on involuntary (350,000
conv. )
Accounting profit 450,00 30 Income tax
subject to tax 0 % expense 135,000
Temporary differences:
Less:  Taxable Less: 
temporary difference Deferred tax
(TTD) 'FI>TI': liability (DTL):
(50,000 30
Excess depreciation ) % (15,000)
400,00 30 Current tax 120,0
Taxable profit 0 % expense 00
Current tax expense
165
120,000
Estimated tax payments during 20x1
(70,000)
Income tax payable - Dec. 31, 20x1
50,000
2. A
Solution:
Multiply by
Less: Non-taxable
income
Income from exempt (60,000
bonds )
Proceeds from life (100,000
insurance )
Accounting profit 440,00 30 Income tax 132,00
subject to tax 0 % expense 0
(120,000 30
320,00 30 Current tax 96,0
3. B
Solution:
Analysis:
 The higher depreciation recognized in financial reporting
compared to taxation makes financial income less than taxable
income (FI<TI). Therefore, the ₱8,000 difference represents a
deductible temporary difference – an addition in the formula.
 Income under financial reporting (equity method) 35,000
25,000
Dividends received
Tax deduction (80% x 25K) (20,000)
Taxable income 5,000
Taxable temporary difference (FI>TI) –
deduction 30,000
Multiply by
166
Permanent differences: -
subject to tax 0 % expense 30,000
30
Income (equity method) (30,000) % (9,000)
Add:  Deductible
temporary difference Add:  Deferred
(DTD) 'FI<TI': tax asset (DTA):
30
Excess depreciation 8,000 % 2,400
30 Current tax 23,40
Taxable profit 78,000 % expense 0
4. C (650,000 taxable income x 30%) = 195,000 current tax

expense
5. C
Solution:
Multiply by
Description of items Tax Description of items
rate
Pretax income before
depn. 100,000
(12,000
Depreciation expense * )
Pretax income after
depn. 88,000
Permanent differences: -
30
Acctg. profit subj. to tax 88,000 % ITE 26,000
Less: Excess depreciation
in taxation over financial
reporting (FI>TI) 30 (2,000
(20,000 – 12,000*) (8,000) % Less:  DTL )
30
Taxable profit - 20x2 80,000 % CTE 24,000
*(70,000 – 10,000) ÷ 5 = 12,000
6. C (12,000 x 25%) = 3,000
7. B
Solution:
167
Rent income - Financial reporting (36,000 x 6/12) 18,000
Rent income - Taxation 36,000
Deductible temporary difference (FI < TI) 18,000
Multiply by: Future tax rate 40%
Deferred tax asset 7,200
8. C
Solution:
Accrual Installment
Year Difference
method method
20x8 800,000 300,000
20x9 1,300,000 700,000
Totals 2,100,000 1,000,000 1,100,000
Multiply by: Tax rate 25%
Deferred tax liability - Dec. 31, 20x9 275,000
9. A (25,000 taxable temporary difference x 35%) = 8,750
10. C (300,000 taxable income x 30%) = 90,000
11. D
Solution:
Year Reversals* Tax rate Deferred tax
15,00
20x1 50,000 30% 0
12,50
20x2 50,000 25% 0
12,50
20x3 50,000 25% 0
40,00
0
*Lower depreciation per financial statements 150,000

Divide by: 3
Equal amounts of reversals 50,000
12. C
Solution:
Decrease in DTA (the beginning balance) 9,000
Increase in DTL (70K TTD x 30%) 21,000
Deferred tax expense 30,000
13. C
168
Solution:
DTA, Dec. 31, 20x1 before adjustment 20,000
Allowance (20,000 x 10%) (2,000)
DTA, Dec. 31, 20x1 after adjustment 18,000
DTA, Dec. 31, 20x0 15,000

Increase in DTA during 20x1 3,000
10,00 (squeeze
Income tax expense 0 )
Add: Increase in DTA during 20x1 3,000
Current tax expense (equal to income tax 13,00
payable) 0 (start)
14. A
Solution:
Share in associate’s profit 180,000
(30,000
Dividends received
)
Share in undistributed earnings 150,000
Multiply by: Percentage subject to taxation (100% - 80%) 20%
Taxable temporary difference 30,000
Multiply by: Substantially enacted tax rate for future periods 30%
Deferred tax liability – year-end 9,000
15. D (300,000 pretax income x 40%) = 120,000. The reversal of

deferred tax asset affects only the current tax expense but not
income tax expense.
16. C (1,000 taxable income x 30%) = 300
17. D
Solution:
Depreciation (FI>TI); TTD; DTL
(800 x 25% rate in 20x4, the yr. of reversal*) (200)
Warranty costs (FI<TI); DTD; DTA
(100 x 30% rate in 20x3) + (300 x 25% rate in 20x4) 105
Deferred tax expense (95)
* Depreciation reverses in 20x4 because it is on this year that the ‘minus’
function becomes an ‘addition’.
169
18. D
Solution:
Year of Deferred tax
reversal Amounts Tax rate asset
20x1 100,000 30% 30,000
20x2 50,000 30% 15,000
20x3 50,000 30% 15,000
20x4 100,000 35% 35,000
95,000
19. A
Solution:
Concept: If the carrying amount (CA) of an asset exceeds its tax
base (TB), the difference is a taxable temporary difference which, if
multiplied by the tax rate, results to a deferred tax liability.
“For an asset: CA > TB = difference is TTD; TTD x Tax rate = DTL”
Consequently:
“For a liability: CA < TB = = difference is TTD; TTD x Tax rate = DTL”
In all of the items in the problem, the carrying amounts of the assets
(i.e., equipment and installment receivables) as of December 31,
20x1 exceed their tax bases (CA>TB). Therefore, the differences are
taxable temporary differences which give rise to deferred tax liability
and not deferred tax asset.
Also, the carrying amounts of the liabilities (i.e., warranty and deferred
compensation) as of December 31, 20x1 are less than their tax
bases. Therefore, the differences are taxable temporary differences
which give rise to deferred tax liability and not deferred tax asset.
Conclusion: No deferred tax asset is recognized on December 31,

20x1.
20. D
Solution:
Concept: If the carrying amount (CA) of an asset exceeds its tax
base (TB), the difference is a taxable temporary difference which, if
multiplied by the tax rate, results to a deferred tax liability.
“For an asset: CA > TB = difference is TTD; TTD x Tax rate = DTL”
Excess of CA over TB of asset (Taxable temp.

difference) 250,000
170
Multiply by: Enacted future tax rate 40%
Deferred tax liability 100,000

11 21 41 51
1. C D A
. . 31. C . C . A
12 22 42 52
2. D B C
. . 32. D . A . C
13 23 43 53
3. A B A
. . 33. C . A . B
14 24 44 54
4. A C B
. . 34. C . D . B
15 25 45
5. A C A
. . 35. B . C
16 26 46
6. D B D
. . 36. A . D
17 27 47
7. D B C
. . 37. D . D
18 28 48
8. A C D
. . 38. A . A
19 29 49
9. A B C
. . 39. C . C
10 20 30 50
A C D
. . . 40. B . D
Solution:
1. C (4,000 – 2,400) = 1,600
2. D Nil
3. A 4,000
4. A 4,000
5. A 4,000
6. D Nil
7. D Nil
8. A 4,000
9. A 4,000
171
10. A 4,000
11. D
Solution:
Multiply by
Add: Non-deductible
expenses:
Loss on expropriation 140,000
Premium on life
insurance 24,000
Less: Non-taxable
income
Non-taxable interest (20,0
income 00)
Accounting profit 544,00 30 Income tax 163,20
subject to tax 0 % expense 0
(40,000 30
Add:  Deductible
temporary difference Add:  Deferred
(DTD) 'FI<TI' tax asset (DTA):
30
Warranty expense 60,000 % 18,000
Rent received in 30
advance 32,000 % 9,600
596,00 30 Current tax 178,8
12. B (See solution above)
13. B (-12,000 change in DTL) + (18,000 + 9,600 change in DTA) =

15,600 deferred tax benefit
14. C 178,800 current tax expense – 80,000 tax payments = 98,800
15. C
How much is the deferred tax liability to be presented in the year-
end statement of financial position?
a. 24,600 b. 28,400 c. 26,400 d. 24,800
172
16. B
How much is the deferred tax asset to be presented in the year-
end statement of financial position?
a. 34,600 b. 38,400 c. 36,400 d. 34,800
Comprehensive problem
17. B
BELLICOSE WARLIKE Co. is determining the amount of its
pretax accounting income for the year by making adjustment to
taxable income from the company's year-end income tax return.
The tax return indicates taxable income of ₱400,000, on which a
tax liability of ₱120,000 has been recognized (₱400,000 x 30% =
₱120,000). Additional information is shown below:
Goodwill impairment loss not included as a deduction
in 140,000
the tax return but may be deducted for financial
reporting.
Interest income on savings and time deposits with
private banks 24,000
Revenues from installment sales are recognized as
goods are sold but are taxed only when installment
payments are collected. 160,000
Excess of depreciation recognized for financial
reporting
over depreciation recognized for taxation purposes 40,000
due
to shorter depreciation period used for financial
reporting
Bad debt expense recognized using the allowance
method 60,000
How much is the pretax income?

a. 460,000 b. 344,000 c. 576,000 d. 480,000
Comprehensive problem – Asset-liability method

Use the following information for the next five questions:
Taken from the records of SCHOLIAST ANNOTATOR Co. as of
December 31, 20x1 is the following information:
Carrying Tax Differen
amount base ce
2,000,00
Computer software cost 2,000,000 - 0
2,400,0 1,600,00
Machinery 4,000,000 00 0
173
Accrued liability - health 800,00
care 800,000 - 0
Additional information:
 Development costs of software after technological feasibility was
established were capitalized for financial reporting. Such costs
were recognized as outright deductions for tax purposes.
 Straight line method is used in depreciating the machinery while
sum-of-the-years’ digits method is used for tax purposes.
 Health care benefits are accrued as incurred but are tax deductible
only when cash is actually paid.
 Pretax profit for 20x1 is ₱4,000,000. Income tax rate is 30%.
 There were no temporary differences as of January 1, 20x1.
18. C
How much is the deferred tax liability as of December 31, 20x1?
a. 1,800,000 b. 1,240,000 c. 1,080,000 d.
1,420,000
19. B
How much is the deferred tax asset as of December 31, 20x1?
a. 180,000 b. 240,000 c. 108,000 d. 142,000
20. C
How much is the income tax expense for the year?
a. 1,360,000 b. 1,240,000 c. 1,200,000 d.
1,420,000
21. How much is the current tax expense for the year?
a. 360,000 b. 240,000 c. 200,000 d. 420,000
22. How much is the deferred tax expense (benefit) for the year?
a. 480,000 b. (480,000) c. 840,000 d. (840,000)
Comprehensive problem
Use the following information for the next five questions:
PERNICOUS DEADLY Co. has the following information from its
comparative financial statements.
20x2 20x1
Trade account receivable from service 6,000,00 4,800,00
revenues 0 0
Prepaid insurance 480,000 400,000
36,000,0 38,000,0
Building - net of accumulated depreciation 00 00
Estimated liability for warranty obligation 1,200,00 1,120,00
174
0 0
Additional information:
 PERNICOUS recognizes revenues from service fees as services
are rendered but are taxed only when cash is collected. Total
collections in 20x2 amounted to ₱3,200,000.
 The prepaid insurance account pertains to the unexpired portion of
life insurance premiums taken on the life of key personnel.
PERNICOUS is the irrevocable beneficiary of the insurance policy.
Total premiums paid in 20x2 were ₱200,000.
 The building was acquired on January 1, 20x1 and is depreciated
over an estimated useful life of 20 years with no residual value.
The straight line method of depreciation is used for financial
reporting while the double declining balance method is used for
taxation.
 Warranty expense is recognized at the time goods are sold but are
tax deductible only when actually paid. Tax deductible warranty
expense for 20x2 amounted to ₱160,000.
 Pretax income in 20x2 is ₱4,000,000. Income tax rate is 30%.
23. How much is the deferred tax asset as of December 31, 20x1?
a. 336,000 b. 284,000 c. 341,000 d. 893,000
24. How much is the deferred tax liability as of December 31, 20x1?
a. 1,480,000 b. 2,040,000 c. 1,490,000 d.
1,520,000
25. How much is the deferred tax asset as of December 31, 20x2?
a. 360,000 b. 480,000 c. 479,000 d. 240,000
26. How much is the deferred tax liability as of December 31, 20x2?
a. 3,000,000 b. 1,800,000 c. 1,080,000 d.
2,880,000
27. How much is the income tax expense for 20x2?

a. 1,880,000 b. 1,479,000 c. 1,236,000 d.
1,420,000
28. How much is the current tax expense for 20x2?
a. 880,000 b. 479,000 c. 236,000 d. 420,000
Reversal of deferred tax asset and liability

Use the following information for the next four questions:
INFIRM SICK Co. started its operations on January 1, 20x1.
Information on temporary differences during the first two years of
operations is shown below.
175
Dec. 31, 20x2 Dec. 31, 20x1
Carryi Carryi
ng ng
amou Tax Diffe- amou Tax Diffe-
nt base rence nt base rence
Asset 400,0 360,00 480,0 400,00
s 00 0 40,000 00 0 80,000
Liabiliti 200,0 172,00 240,0 180,00
es 00 0 28,000 00 0 60,000
Pretax income were ₱1,600,000 and ₱2,000,000 in 20x2 and 20x1,

respectively. Income tax rate is 30%.
29. How much is the income tax expense in 20x1?

a. 480,000 b. 620,000 c. 600,000 d. 594,000
30. How much is the current tax expense in 20x1?

a. 549,000 b. 476,400 c. 600,000 d. 594,000
31. How much is the income tax expense in 20x2?

a. 600,000 b. 420,000 c. 480,000 d. 449,000
32. How much is the current tax expense in 20x2?

a. 476,400 b. 484,200 c. 594,000 d. 482,400
Revaluation surplus
Use the following information for the next six questions:
On January 1, 20x1, COPIOUS RICH purchased machinery for
₱4,000,000. The equipment is depreciated using the straight line
method over an estimated useful life of 10 years with no residual
value. On January 1, 20x3, the equipment was revalued at a
replacement cost of ₱6,000,000 with no change in useful life. The
pretax income before deduction for depreciation expense in 20x3 is
₱4,000,000. Income tax rate is 30%.
33. How much is the revaluation surplus as of January 1, 20x3?

a. 1,600,000 b. 1,220,000 c. 1,120,000 d.
1,200,000
34. How much is the related deferred tax liability as of January 1,

20x3?
a. 0 b. 380,000 c. 480,000 d. 400,000
35. How much is the revaluation surplus as of December 31, 20x3?

a. 4,200,000 b. 980,000 c. 870,000 d.
924,000
176
36. How much is the related deferred tax liability as of December 31,
20x3?
a. 420,000 b. 98,000 c. 87,000 d. 424,000
37. How much is the income tax expense for 20x3?

a. 1,200,000 b. 1,220,000 c. 1,380,000 d.
1,020,000
38. How much is the current tax expense for 20x3?
a. 1,080,000 b. 1,980,000 c. 1,870,000 d.
960,000
Compound instruments
39. On January 1, 20x1, SQUELCH SILENCE Co. issued a
convertible bond with face amount of ₱4M for ₱4.8M. The bond
matures in seven years and can be converted into ordinary
shares at any time. At the time of issuance, the bond is selling at
110 without the conversion feature. Income tax rate is 30%. How
much is the deferred tax liability arising from the issuance of the
compound financial instrument on January 1, 20x1?
a. 400,000 b. 280,000 c. 120,000 d. 0
Limitation on recognition of deferred tax asset

LEEWAY TOLERANCE Co. has the following information:
 Deductible temporary differences on December 31, 20x1 is
₱4,000,000.
 There are no temporary differences as of the beginning of the
year.
 Pretax income in 20x1 is ₱5,200,000 on which income tax
expense of ₱1,560,000 was recognized. Income tax rate is 30%.
 Taxable income in 20x1 is ₱9,200,000 on which current tax
expense of ₱2,760,000 was recognized.
LEEWAY’s results of operations have been declining. This has raised

doubt on whether deferred tax assets will be realized in the future.
LEEWAY then reassessed its deferred tax asset and concluded that it
is more likely than not that only half of the deferred tax asset will be
realized in the future.
40. How much is the adjusted deferred tax asset?

a. 1,200,000 b. 600,000 c. 800,000 d. 0
41. How much is the adjusted income tax expense?

a. 1,560,000 b. 1,200,000 c. 2,160,000 c.
960,000
177
42. How much is the adjusted deferred tax expense (benefit)?
a. (600,000) b. 600,000 c. (1,200,000) d. 1,200,000
43. How much is the adjusted current tax expense?

a. 2,760,000 b. 2,160,000 c. 3,360,000 d.
960,000
Deferred tax asset from loss carry forward

44. Information on COLTISH UNDISCIPLINED Co.’s operations
during the year is shown below.
 Revenues are recognized for financial reporting at point of sale
while revenues are taxed on cash basis. Gross profit recognized
for financial reporting amounted to ₱4,000,000 while taxable gross
profit is ₱3,200,000.
 Retirement benefit costs are deducted for financial reporting as
services are rendered by employees but are tax deductible only
when actually paid to retiring employees. Current service cost
recognized during the year is ₱400,000 while benefits paid to
retiring employees amounted to ₱600,000.
 Research costs amounting to ₱360,000 are expensed immediately
during the year for financial reporting. For taxation purposes,
research costs are amortized over a three-year period.
Amortization of research cost deducted for taxation purposes is
₱120,000.
 Unrealized losses of ₱40,000 was recognized during the year in
profit or loss on an investment in held for trading equity securities.
No equivalent adjustment was made for taxation purposes. Any
gain or loss on actual disposal of such securities is taxable (tax
deductible).
 Payments during the year for fines, surcharges, and penalties
arising from violation of law amounted to ₱160,000.
 COLTISH reported pretax income of ₱400,000. Income tax rate is
30%.
 Any operating loss can be carried over to the next period.
COLTISH expects to realize the economic benefit of any operating
loss carry forward.
How much are the deferred tax liability and deferred tax asset,
respectively?
Deferred tax asset Deferred tax liability
a. 300,000 132,000
b. 84,000 300,000
c. 300,000 84,000
d. 132,000 300,000
178
Investment in subsidiary
45. SURLY BAD TEMPERED Co. purchased goods with selling price
of ₱2,000,000 from an 80% owned subsidiary. The cost of the
goods to the subsidiary is ₱1,200,000. SURLY and its subsidiary
operate in different tax jurisdictions but have similar tax rates of
30%. The entire inventory is held by SURLY at year-end. How
much is the deferred tax asset arising from the transaction?
a. 600,000 b. 360,000 c. 240,000 d. 0
Investment in associate – deferred tax liability

46. PRENTICE Corporation uses the equity method to account for its
25% investment in LEARNER, Inc. During the year, LEARNER
reported profits of ₱4,000,000 and declared dividends of
₱800,000. Additional information is shown below:
 PRENTICE does not control the dividend policy of LEARNER. It is
probable that all undistributed earnings of LEARNER will be
distributed in future periods.
 In the jurisdiction where PRENTICE operates, dividends received
are eligible for 80% deductions.
 There are no other temporary differences.
 Income tax rate during the year is 30%. Income tax rate in
subsequent years based on a substantially enacted tax law by
year-end is 35%.
How much is the deferred tax liability as of year-end?

a. 48,000 b. 280,000 c. 240,000 d. 56,000
Investment in associate – income tax payable

47. On January 1, 20x1, HACK Corporation acquired 25% interest in
CHOP, Inc.. During the year, CHOP reported profits of
₱4,000,000 and declared and paid dividends of ₱800,000.
HACK’s pretax income is ₱1,400,000 in 20x1. The only temporary
difference arises from HACK’s investment in associate. Under the
jurisdiction where HACK operates, dividends received are eligible
for 80% dividends received deduction. Income tax rate is 30%.
How much is the current tax expense for the year?
a. 960,000 b. 288,000 c. 420,000 d. 132,000
Measurement of income tax expense – change in tax rate

48. SUPPLICATE BEG Co. has the following information relating to
its income tax as of December 31, 20x1:
 Provision for probable loss on litigation of ₱4,800,000 is
recognized for financial reporting. This amount is tax deductible
179
only when actually paid. SUPPLICATE expects to pay for the
accrued loss in 20x2.
 Revenue for financial reporting is recognized based on percentage
of completion while revenue for taxation purposes is recognized
based on collections on progress billings. Total revenue
recognized for financial reporting is ₱16,000,000 while revenue
recognized for taxation purposes is ₱12,800,000.
 Pretax income for the year is ₱16,000,000. Income tax rate for
20x1 is 30%. However, an enacted tax law that will take effect
starting January 1, 20x2 requires a tax rate of 32%.
 There were no temporary differences as of January 1, 20x1.
How much is the income tax expense?

a. 4,768,000 b. 5,120,000 c. 1,280,000 d. 1,192,000
Measurement of current tax liability and deferred tax liability

Use the following information for the next three questions:
WASHY PALE Co. follows a fiscal year that ends in June 30. On
January 1, 20x1, there has been a change in the tax rate in the
jurisdiction where WASHY Co. operates. The tax rate prior to January
1, 20x1 is 30% while the newly enacted tax rate that will apply from
January 1, 20x1 onwards is 35%. WASHY reported pretax profit of
₱1,280,000 for the fiscal year ended June 30, 20x1. The only
temporary difference pertains to a ₱16,000, one-year fire insurance
premium taken by WASHY on its building on January 1, 20x1. The
premium paid is tax deductible in full upon payment. There were no
temporary differences as of July 1, 20x0. There were also no
payments for income tax during the year.
49. How much is the deferred tax liability as of June 30, 20x1?
a. 28,000 b. 8,000 c. 2,800
d. 0
50. How much is the current tax liability as of June 30, 20x1?
a. 381,600 b. 450,800 c. 384,000 d. 413,400
51. How much is the income tax expense for the fiscal year ended
June 30, 20x1?
a. 416,200 b. 413,400 c. 448,000 d. 410,600
Measurement of deferred tax asset
52. On January 1, 20x1, CALLOW IMMATURE Co. does not have
any temporary differences. However, during the year, CALLOW
identified that temporary difference may result from a warranty
expense of ₱480,000 that was recognized for financial reporting
during 20x1. For taxation purposes, warranty expense is tax
180
deductible only when paid. Warranty costs paid during the year
totaled ₱200,000. It is expected that the remaining accrued
warranty costs will be paid as follows: ₱160,000 in 20x2 and
₱120,000 in 20x3. Income tax rate for 20x1 is 30%. However, as
of December 31, 20x1, a new tax law was enacted. Under the
new law, tax rate for 20x2 is 32% and tax rate in 20x3 and years
thereafter is 35%. How much is the deferred tax asset as of
December 31, 20x1?
a. 86,400 b. 51,200 c. 93,200
d. 42,000
Different tax rates apply to different levels of taxable income

53. On December 31, 20x1, an entity has an asset of ₱16,000 for
interest receivable that will be taxed when the cash is received in
20x2. Tax is payable at 20 per cent on the first ₱2,000,000 of
taxable profit earned and 30 per cent on any remainder (i.e.,
excess above ₱2,000,000). In 20x1 the entity earned taxable
profit of ₱1,800,000. In 20x2 the entity expects to earn taxable
profit of ₱2,200,000. What amount should the entity recognize for
the deferred tax liability relating to the interest receivable?
a. 360,000 b. 3,345 c. 3,200 d. 0
Revaluation of non-depreciable asset

54. On December 31, 20x1, the land of GUILE DECEITFULNESS Co.
with a historical cost of ₱80,000,000 has been appraised at
₱140,000,000. Income tax rate applicable to profits is 30% and
the tax rate applicable to profits made on the sale of property is
6%. How much is the deferred tax arising from the transaction?
a. 56,400,000 b. 3,600,000 c. 18,000,000 d. 0
Exercises
1. Answer: P800 (P2,000 – P1,200)

2. Answer: Nil or zero
3. Answer: P2,000
4. Answer: P2,000
5. Answer: P2,000
8. Answer: P2,000
9. Answer: P2,000
10. Answer: P2,000
11. Solutions:
181
Requirements (a) and (b) – Income tax expense and Current tax
expense
Mul-
tiply
Description of
Description of items by
Tax items
rate
200,00
Pretax income 0
Add: Non-deductible
expense:
Loss on expropriation 70,000
Premium on life
insurance 12,000
Less: Non-taxable
income
Non-taxable interest (10,
income 000)
Accounting profit 272,0 Income tax
subject to tax 00 30% expense 81,600
Less: Taxable
(20,000
Excess depreciation ) 30% (6,000)
Add: Deductible
(DTD) 'FI<TI' asset (DTA):
Warranty expense 30,000 30% 9,000
Rent received in
advance 16,000 30% 4,800
298,0 Current tax 89,40
Taxable profit 00 30% expense 0
Answers:
Requirement (a): 81,600
Requirement (b): 89,400
Requirement (c) – Deferred tax expense/benefit

Increase in DTL (6,000)
Increase in DTA (9,000 + 4,800) 13,800
Deferred tax benefit 7,800
Requirement (d) – Current tax payable

Current tax expense 89,400
Quarterly income taxes paid ( 40,000)
Income tax payable 49,400
182
Requirements (e) and (f) – DTL and DTA in the statement of
financial position
Ending balance of DTL = Ending balance of TTD x Tax rate

DTL, end. = (TTD beginning + increase during the year) x Tax rate
DTL, end. = (24,000 + 20,000) x 30%
Ending balance of DTL = 13,200
Ending balance of DTA = Ending balance of DTD x Tax rate

DTA, end. = (DTD beginning + increase during the year) x Tax rate
DTA, end. = [18,000 + (30,000 + 16,000)] x 30%
Ending balance of DTA = 19,200
12. Solution:
Pretax income (squeeze) 172,000
Add: Non-deductible expense:
Goodwill impairment loss not tax deductible 70,000
Less: Interest income subject to final tax (12,000)
Accounting profit subject to tax 230,000
Less: Taxable temporary difference (TTD) 'FI>TI':
Revenues accrued but taxed on cash basis (80,000)
Add: Deductible temporary difference (DTD) 'FI<TI'
Excess of depreciation 20,000
Bad debts recognized under allowance method 30,000
Taxable profit (start) 200,000
13. Solutions:
Requirement (a) – DTL and DTA
Assets:
Excess of carrying amount of software over its tax base 1,000,000
Excess of carrying amount of machinery over its tax base 800,000
Taxable temporary difference (TTD) 1,800,000
Deferred tax liability – Dec. 31, 20x1 540,000
Liability:
Excess of carrying amount of accrued liability over its
tax base 400,000
Deductible temporary difference (DTD) 400,000
Deferred tax asset – Dec. 31, 20x1 120,000
Requirement (b) – Income tax expense and Current tax expense

for the year
183
Mul
-
tipl
Description of
Description of items y
by items
Tax
rate
Pretax income 2,000,000
Add/Less: Permanent
differences -
Accounting profit 2,000,00 Income tax 600,00
subject to tax 0 30% expense 0
Less: Taxable
temporary (1,800,0 Deferred tax (540,000
difference (TTD) 00) 30% liability (DTL): )
Add: Deductible
temporary 400,00 Deferred tax 120,0
difference (DTD) 0 30% asset (DTA): 00
Taxable profit – 600,00 Current tax 180,0
20x1 0 30% expense 00
Answer to Requirement (b): P600,000 income tax expense and

P180,000 current tax expense
Requirement (c) – Deferred tax expense/benefit

Increase in DTL (540,000)
Increase in DTA 120,000
Deferred tax expense ( 420,000)
14. Solutions:
Requirement (a) – DTL and DTA in statement of financial position
in 20x1 and 20x2
20x1
Trade account receivable – December 31, 20x1:
Tax base 0
Taxable temporary difference 2,400,000
Multiply by tax rate 30%
Deferred tax liability – December 31, 20x1 720,000
Building – December 31, 20x1

Tax base* (18,000,000)
184
*Tax base of the building as of December 31, 20x1 is computed as
follows:
Divide by: Unexpired life (straight line)a 19/20
Historical cost 20,000,000
Accumulated depreciation – December 31, 20x1
(20M x 10%) b ( 2,000,000)
Tax base – December 31, 20x1 18,000,000
a
The building is 1-year old as of December 31, 20x1 because the
acquisition date is January 1, 20x1.
b
Double declining rate is 10% (2 ÷ 20 years).
Estimated liability for warranty obligation – December 31, 20x1:

Carrying amount – December 31, 20x1 560,000
Tax base 0
Deductible temporary difference 560,000
Deferred tax asset – December 31, 20x1 168,000

Deferred tax liability – December 31, 20x1
(720,000 + 300,000) 1,020,000
20x2
Trade account receivable – December 31, 20x2:
Tax base 0
Building – December 31, 20x2:

Tax base* (16,200,000)
*Tax base of the building as of December 31, 20x2 is computed as

follows:
Historical cost (see previous computation) 20,000,000
Accumulated depreciation – December 31, 20x2
[2M + (18M x 10%)] ( 3,800,000)
Tax base – December 31, 20x2 16,200,000
185
Estimated liability for warranty obligation – December 31, 20x1:
Carrying amount – December 31, 20x1 600,000
Tax base 0
Deferred tax liability – December 31, 20x2

(900,000 + 540,000) 1,440,000
Requirement (b) - Income tax expense and Current tax expense

for 20x2
Mul-
tiply Description
Description of items by of items
Tax
rate
Pretax income 2,000,000
Add: Non-deductible
expense:
Premium on life
insurance* 60,000
Accounting profit Income tax
subject to tax 2,060,000 30% expense 618,000
Increase in
Less: Increase in TTD DTL:
[(3M + .18M) - (2.4M + (1.440M – (420,000
1M)] (1,400,000) 30% 1.020M) )
Increase in
Add: Increase in DTD DTA: (180K 12,0
[(600,000) - (560,000)] 40,000 30% – 168K) 00
Current tax
Taxable profit - 20x2 700,000 30% expense 210,000
*Prepaid insurance
Jan. 1, 20x2 200,000
Premiums Insurance expense
paid 100,000 60,000 (squeeze)
240,00
0 Dec. 31, 20x2
15. Solutions:
20x1
186
Mul- Description of
Description of items tiply items
by Tax
rate
1,000,00
Pretax income 0
Add/less: Permanent
differences -
Less: Increase in TTD
(CA of asset > TB  (12,
FI>TI  TTD  DTL) (40,000) 30% Increase in DTL 000)
Add: Increase in DTD 30,000 30% Increase in DTA 9,000

Current tax 297,0
Taxable profit - 20x1 990,000 30% expense 00
20x2
Mul
-
tipl
Description of y Description of
items by items
Tax
rat
e
Add/less: Permanent
differences -
subj. to tax 0 % expense 240,000
Add: Decrease in
TTD (40,000 - 20,00 30 Decrease in 6,00
20,000) 0 % DTL 0
Less: Decrease in (16,00 30 Decrease in (4,800

DTD (30K – 14K) 0) % DTA )
Taxable profit - 804,00 30 Current tax
20x2 0 % expense 241,200
Answers:
Income tax expense – 20x1: 300,000
Current tax expense – 20x1: 297,000
Income tax expense – 20x2: 240,000
Current tax expense – 20x2: 241,200
187
16. Solutions:
Requirement (a) – Revaluation surplus and DTL as of January 1,
20x3
Multiply by: Unexpired life as of January 1, 20x3 8/10
Carrying amount as of January 1, 20x3 before revaluation 1,600,000
Replacement cost 3,000,000

Multiply by: Observed depreciation rate 8/10
Depreciated replacement cost 2,400,000
Revaluation surplus before tax = Depreciated replacement cost –

Carrying amount

Carrying amount - January 1, 20x3 (1,600,000)
Revaluation surplus before tax – Jan. 1, 20x3 800,000
The revaluation surplus before tax is allocated as follows:

Revaluation surplus after tax – Jan. 1, 20x3
(800,000 x 70%) = 560,000
Deferred tax liability – Jan. 1, 20x3 (800,000 x 30%) = 240,000
Requirement (b) – Revaluation surplus and DTL as of December

31, 20x3
Multiply by: Unexpired life as of December 31, 20x3 7/10
Carrying amount as of December 31, 20x3
ignoring revaluation 1,400,000
Replacement cost 3,000,000

Multiply by: Observed depreciation rate 7/10
Revaluation surplus before tax = Depreciated replacement cost –

Carrying amount

Carrying amount as of December 31, 20x3
ignoring revaluation (1,400,000)
Revaluation surplus before tax – ending balance 12/31/x1 700,000
Revaluation surplus after tax – Dec. 31, 20x3

(700,000 x 70%) = 490,000
Deferred tax liability – Dec. 31, 20x3 (700,000 x 30%) = 210,000
188
Requirement (c) - Income tax and Current tax expenses for 20x2
Mul-
tiply Description
Tax
of items
rate
Pretax income before
depreciation 2,000,000
Less: Depreciation
expense (2.4M ÷ 8 years) (300,000)
Pretax income after 1,700,00
depreciation 0
Add/ Less: Permanent
differences -
Add: Decrease in TTD:
excess of depreciation
recognized for financial
reporting over taxation Decrease in
purposes 'FI<TI' DTL 30,0
(300,000 - 200,000) 100,000 30% (240K – 210K) 00
1,800,00 Current tax 540,0
Taxable profit - 20x3 0 30% expense 00
17. Solution:
Net proceeds from issuance 2,400,000
(P2M x 110%) (2,200,000)
18. Solutions:
Requirement (a):
Deductible temporary difference - Dec. 31, 20x1 2,000,000
Tax rate 30%
Deferred tax asset before adjustment 600,000
Adjustment 50%
Deferred tax asset after adjustment 300,000
Requirement (b):
Income tax expense before adjustment in
realizable value of DTA 390,000
Adjustment to the realizable value of DTA 150,000
Income tax expense as adjusted 540,000
189
Since the deferred tax asset computed above represents the change
during the year, such amount is also the deferred tax benefit during
the year. The adjusted deferred tax benefit is 300,000 (P600K before
adjustment minus P300K adjustment).
Current tax expense for the year remains at P1,380,000. Current tax
expense is affected only upon reversal of deferred tax asset.
19. Solution:
Excess of gross profit recognized for financial reporting
over taxable gross profit (2M – 1,600,000) – ‘FI>TI’ 400,000
Excess of retirement benefits expense recognized for
taxation over retirement benefits expense recognized
for financial reporting (300,000 – 200,000) – ‘FI>TI’ 100,00
0
Taxable temporary differences 500,000
Multiply by tax rate
30%
Deferred tax liability
150,000
Excess of research cost expensed for financial 120,000

reporting
over tax deductible research expense
(180,000 – 60,000) – ‘FI<TI’
Excess of loss recognized for financial reporting over
tax 20,000
deductible loss – ‘FI<TI’
Deductible temporary differences before operating loss
carry forward 140,000
Operating loss carry forward*
80,000
Deductible temporary differences – adjusted 220,000
Multiply by tax rate
30%
Deferred tax asset
66,000
*Operating loss carry forward is computed as follows:

Add: Non-deductible losses on fines, penalties, and
surcharges 80,000
Accounting profit subject to tax 280,000
Less: Taxable temporary difference (TTD) 'FI>TI': (500,000)
190
Add: Deductible temporary difference before NOLCO 140,00
(DTD) 'FI<TI' 0
Operating loss carry forward (80,000)
20. Solution:
Carrying amount of inventory in consolidated
financial statements (unrealized profit is eliminated) 600,000
Tax base (transaction price) (1,000,000)
Deferred tax asset 120,000
21. Solution:
Associate’s profit for the year 2,000,000
Dividends declared by associate ( 400,000)
Associate’s undistributed earnings probable to be
distributed in the future 1,600,000
Multiply by ownership interest 25%
Share in associate’s undistributed earnings 400,000
Multiply by percentage subject to taxation (100% - 80%) 20%
Taxable temporary difference 80,000
Multiply by substantially enacted tax rate for future
periods 35%
Deferred tax liability – year-end 28,000
22. Solution:
The temporary difference and the related deferred tax are computed
as follows:
Associate’s profit for the year 2,000,000
Share in the profit of the associate – recognized in
profit or loss using the Equity method under PAS 28 500,000
Dividends declared by associate 400,000
Share in dividends – recognized as return of capital 100,000
Multiply by percentage subject to taxation (100% - 80%) 20%
Share in dividends subject to taxation 20,000
Taxable temporary difference (500,000 – 20,000) 480,000

Multiply by substantially enacted tax rate for future
periods 30%
Current tax expense is computed as follows:
191
Mul-
tiply Description
Tax
of items
rate
Add/ Less: Permanent
differences -
Accounting profit Income tax
subject to tax 700,000 30% expense 210,000
Less: Taxable Deferred tax
temporary difference liability
(TTD) ‘FI>TI’ 30% (DTL):
Excess of share in profit
of associate over
dividend received
subject to income tax
[(2M x 25%) – (400K x (480,000 (144,000
25% x 20%)] ) )
Current tax
Taxable profit 220,000 30% expense 66,000
23. Solution:
Description of Tax

items rate
Pretax income START 2M
Permanent differences -
Acctg. profit subj. to SQUEEZE
2M N/A ITE 596K
tax
Revenue (FI>TI) (400K) 32% DTL (128K)
Provision (FI<TI) 600K 32% DTA 192K
Taxable profit 2.2M 30% CTE 660K
24. Solution:
Dec. Income tax expense (2.4M x 32%) 768,00
31, Deferred tax liability 0
20x1 Deferred tax asset 128,00 192,00
Income tax payable 0 0
[(2.4M + 400K – 600K) x 32%]
704,00
0
The amounts “400K” and “600K” pertain to the temporary differences

that have reversed. Decrease in TTD of 400K is added while
decrease in DTD of 600K is deducted from pretax profit in computing
for taxable profit, from which income tax payable is computed.
192
25. Solution:
Description of Tax

items rate
START 640
Pretax income
K
Permanent
-
differences
Acctg. profit subj. 640 SQUEEZ
N/A ITE 208,100
E
to tax K
Insurance
(FI>TI)a (4K) 35% DTL (1,400)
636 N/A
Taxable profit CTE 206,700
K b

a
Insurance expense recognized for financial reporting
(P8K x 6/12) 4,000
Insurance expense recognized for taxation (8,000)
Taxable temporary difference, TTD (FI>TI) (4,000)
b
Current tax expense is computed as follows:
Taxable profit – July 1 to Dec. 31, 20x0 (636,000 x 6/12) 318,000

Tax rate applicable during the period - 20x0 30%
Current tax expense - 1st half of fiscal year 95,400
Taxable profit – Jan. 1 to June 30, 20x1 (636,000 x 6/12) 318,000

Tax rate applicable during the period - 20x1 35%
Current tax expense - 2nd half of fiscal year 111,300

Current tax expense for the fiscal year 206,700
Answers to requirement:
Deferred tax liability: 1,400
Current tax liability: 206,700
Income tax expense: 208,100
26. Solution:
Warranty cost Applicable tax Deferred tax
Year expected to be paid rate asset
20x2 80,000 32% 25,600
20x3 60,000 35% 21,000
Total 140,000 46,600
27. Solution:
Tax on first P1,000,000 of profit (1M x 20%) 200,000
193
Tax on excess profit over P1,000,000 (100K x 30%) 30,000
Tax on expected profit of P550K in 20x2 230,000
Divide by: Expected profit in 20x2 1,100,000
Average rate expected to apply on reversal date 20.91%
Multiply by: Temporary difference 8,000
Deferred tax liability 1,672.73
28. Solutions:
Appraised value 70,000,000
Carrying amount (40,000,000)
Revaluation surplus before tax 30,000,000
Requirement (a):
The entry on December 31, 20x1 is:
Dec. Land 30,000,00
31,
Deferred tax liability (30M x 0 1,800,000
20x1
6%) 28,200,00
Revaluation surplus (30M x 0
94%)
Requirement (b):
Pertinent entries for the sale are:
20x Cash 60,000,00
3 Loss on sale 0
Land 10,000,00 70,000,00
to record the sale of land 0 0
20x Revaluation surplus 28,200,00
3 Retained earnings 0 28,200,00
to transfer directly to retained 0
earnings the related revaluation on the
land sold
20x Deferred tax liability 1,800,000
3 Income tax payable* 1,800,000
to record the reversal of the
deferred tax liability related to the
revaluation surplus
*The effect of the reversal of deferred tax liability is analyzed as

follows:
Taxable gain based on historical cost
(60M selling price – 40M historical cost) 20,000,000
Non-tax deductible loss recognized for financial
reporting but not tax deductible – FI<TI (added back) 10,000,000
Excess of taxable profit over accounting profit (FI<TI) 30,000,000
Reversal of deferred tax liability – increase in
income tax payable 1,800,000
194
The reversal of deferred tax liability is further analyzed as follows:
Increase in income tax payable arising from the taxable gain
on the sale of the land
(60M selling price – 40M historical cost) x 6% 1,200,000
Increase in income tax payable arising from adding back
to pretax income the “loss on sale” recognized for
financial reporting but not tax deductible
(10M x 6%) – FI<TI 600,000
Reversal of deferred tax liability – increase in income
tax payable 1,800,000
195
Chapter 31 – Shareholders’ Equity (Part 1)
1. B 6. A
2. B 7. A
3. A 8. D
4. B 9. C
5. A 10. A

1. A 6. B
2. A 7. D
3. C 8. A
4. D 9. C
10
5. D D
.
Solutions:
1. A
Solution:
Ordinary shares, ₱3 par 600,000
Treasury stock, at cost (50,000)
Accumulated other comprehensive income (Debit) (20,000)
Retained earnings appropriated for uninsured
earthquake losses 150,000
Retained earnings unappropriated 200,000
Total shareholders' equity 1,680,000
2. A
Solution:
Ordinary Preference
Total issue 600,00 300,00
price 0 0
Par value 20,000 60,000
Share premium 580,000 240,000 820,000
3. C
Solution:
196
No. of Fair Allocatio
sh. value Totals n
Ordinary sh. 1,000 36.00 36,000 32,000
Preference
sh. 2,000 27.00 54,000 48,000
90,000 80,000
4. D
Solution:
Jan. Share capital (100,000 x ₱10) 1,000,00
2, Sh. premium – orig. issuance (2.7M x 0
20x3 100K/900K) 300,000
Retained earnings 500,000 1,800,000
Cash
Share premium Retained earnings

Dec. 31, 20x2 2,700,000 1,300,000
Debit (300,000) (500,000)
Jan. 2, 20x3 2,400,000 800,000
5. D
Solution:
Jan. Cash (20,000 x 15) 300,000
5,
Ordinary share (20,000 x 10) 200,000
20x1
July Treasury shares (5,000 x 17) 85,000
14,
Cash 85,000
20x1
Dec. Cash (5,000 x 20) 100,000
27,
Treasury shares (5,000 x 17) 85,000
20x1
Share premium – Treasury shares 15,000
6. B
Solution:
Dec. Cash (3,000 x 25) 75,000
27,
Treasury shares (3,000 x 18) 54,000
20x1
Share premium – Treasury shares 21,000
7. D
8. A
9. C (120,000 rights x ₱0.10) = 12,000 debit to share premium
10. D
197
Solutions:
Cash
675,000
Accounts receivable (net) [2.695M - 1M + (125K x
4)] 2,195,000
Inventory
2,185,000
Total current assets 5,055,000
Net sales and other revenues 13,360,000

(11,180,000
Costs and expenses
)
Profit before tax 2,180,000
Income tax expense 654,000
Income tax payments during the year (475,000)
Adjusted income tax payable 179,000
Accounts payable and accrued liabilities

1,801,000
Income tax payable
179,000
Working capital = Current assets – Current liabilities

Working capital = (5,055,000 – 1,980,000) = 3,075,000
Net sales and other revenues 13,360,000

(11,180,000
Costs and expenses
)
Profit before tax 2,180,000
Income tax expense (30% x 2,180,000) (654,000)
Profit after tax 1,526,000
Retained earnings, Jan. 1 3,350,000
Retained earnings, Dec. 31 4,876,000
2,300,00
Ordinary shares
0
3,680,00
Share premium
0
4,876,00
Retained earnings, Dec. 31, 20x1
0
198
10,856,00
Shareholders' Equity 0

1. D 11. D 21. C 31. C
2. A 12. A 22. B 32. C
3. B 13. B 23. D 33. C
4. C 14. C 24. C 34. D
5. D 15. C 25. B 35. D
6. D 16. D 26. D 36. A
7. C 17. A 27. C
8. A 18. C 28. C
9. C 19. C 29. B
10. D 20. A 30. C
Solution:
Exercises
1. Solutions:
Requirement (a):
Jan. 1, 20x1
Memorandum method Journal entry method
Memo entry – Authorized capitalization Unissued share capital 2M
is P2,000,000 divided into 20,000 Authorized share capital 2M
shares with par value per share of
P100.
Cash on hand 125K Cash on hand 125K

(2M x 25% x 25%) (2M x 25% x 25%)
Subscription receivable 375K Subscription receivable 375K
Subscribed share capital 500K Subscribed share capital 500K
(2M x 25%) (2M x 25%)
Feb. 1, 20x1
Cash on hand 300K* Cash on hand 300,000*
Subscription receivable 300K Subscription receivable 300,000
Subscribed share capital 400K Subscribed share capital 400K
Share capital 400K Unissued share capital 400K
199
*Subscription price of 2,000 shares (2,000 x P200) 400,000
Portion already paid (400,000 x 25%) (100,000)
Balance collected 300,000
Feb. 28, 20x1

Cash on hand 200K Cash on hand 200K
(1,000 x P200) (1,000 x P200)
Share capital 200K Unissued share capital 200K
Requirement (b):
Share capital 600,000 Authorized share capital 2,000,000
Subscribed share capital 100,000 Unissued share capital (1,400,000)
(75,000
Subscription receivable* ) Issued share capital 600,000
Subscribed share capital 100,000
Subscription receivable* (75,000)
Total Share capital 625,000 Total Share capital 625,000
2. Solution:
Jan. Cash on hand (5,000 x P120) 600,00
1,
Share capital (5,000 x P100) 0 500,00
20x
1 Share premium [5,000 x (P120 – P100)] 0
100,00
0
Jan. Subscription receivable (2,000 x P160) 320,00
31,
Subscribed share capital (2,000 x 0 200,00
20x
1
P100) 0
Share premium [2,000 x (P160 – P100)] 120,00
0
3. Solutions:
Requirement (a):
6% Preference share capital, P100 par value 400,000
Ordinary share capital, P50 par value 1,600,000
Subscribed share capital – ordinary, P50 par value 200,00
0
Legal capital 2,200,000
Requirement (b):
Case #2 – No-par value shares
6% Preference share capital, P100 par 400,000
Ordinary share capital, P50 stated value 1,600,000
Share premium – ordinary share capital 600,000
Subscribed share capital – ordinary, P50 stated value 200,000
200
Legal capital 2,800,000
4. Solution:
Jan. Cash on hand (1,000 x P240) 240,00
1,
Share capital (1,000 x P200) 0 200,00
20x1
Share premium [1,000 x (P240 – 0
P200)] 40,000
Jan. Share premium (1,000 x P10) 10,000
1,
20x1 Cash on hand 10,000
5. Solution:
Date Cash on hand (1,000 x P160) 160,00
Discount on share capital 0
Share capital 40,000 200,00
0
6. Solution:
Date Land 160,00
Discount on share capital 0
Share capital 40,000 200,00
0
7. Solutions:
July 1, Treasury shares (1,000 x P90) 90,000
July 1, Retained earnings – unrestricted 90,000
20x1 Retained earnings – appropriated 90,000
Requirement (a):
Sept. Cash on hand (1,000 x P90) 90,000
1, Treasury shares (1,000 x P90) 90,000
20x1
Sept. Retained earnings – appropriated 90,000
1, Retained earnings – unrestricted 90,000
20x1
Requirement (b):
1, 20x1 Treasury shares (1,000 x P90) 0 90,00
Share premium – treasury 0
shares 50,00
0
1, 20x1 Retained earnings – unrestricted 90,00
0
201
Requirement (c):
1, (a) Share premium – treasury -
20x1 shares 30,000
(b) Retained earnings 90,00
Treasury shares (1,000 x P90) 0
1, Retained earnings – 90,00
20x1 unrestricted 0
8. Solution:
Requirement (a):
July 1, Treasury shares (1,000 x P80) 80,00
20x1 Cash in bank 0 80,00
0
July 1, Retained earnings – unrestricted 80,00
20x1 Retained earnings – appropriated 0 80,00
0
Sept. Share capital (1,000 x P100) 100,00

1, Share premium – original issuance 0
20x1
[1,000 x (P320K/16K sh.)] 20,000
Treasury shares (1,000 x P80) 80,00
Share premium - retirement 0
40,00
0
1,
Retained earnings – unrestricted 80,00
20x1
0
Requirement (b):
July Share capital (1,000 x P100) 100,00
1, Share premium – original issuance 0
20x (1,000 x P20) 20,000
1 (a) Share premium – treasury shares
(b) Retained earnings (balancing 5,000
figure) 15,000 140,00
Cash in bank (1,000 x P140) 0
9. Solution:
July Treasury shares (1,000 x P100 par value) 100,00
1, Share premium – original issuance (1,000 x 0
20x1 P20) 20,000 80,00
Cash in bank (1,000 x P80) 0
Share premium – treasury shares
202
40,00
0
July Retained earnings – unrestricted 80,000
1,
20x1 Retained earnings – appropriated 80,00
0

1,
Treasury shares (1,000 x P100) 0 100,00
20x1
Share premium – treasury shares 0
10,000
1,
Retained earnings – unrestricted 80,000
20x1
10. Solution:
Dat Cash on hand 200,000
e Land 1,000,00
Share premium – donated 0 1,200,00
capital 0
11. Solution:
The receipt of the shares is recorded through memo entry as follows:
“Received 1,000 shares with par value of P100 from shareholder as
donation.”
The subsequent reissuance of the donated shares is recorded as

follows:
Dat Cash on hand (1,000 x P260) 260,00
e Share premium – donated capital 0 260,00
0
Chapter 32 – Shareholders’ Equity (Part 2)

1
C 6.
. D 11. B
2
A 7.
. B 12. A
3
D 8.
. C 13. A
4
9.
. C A 14. E
5
10.
. A C 15. C
203
11
1. A 6. B A
.
12
2. A 7. C C
.
13
3. A 8. A B
.
14
4. A 9. C C
.
10
5. B B
.
Solutions:
1. A (300,000 + 60,000 profit) = 360,000. The reissuance of the
treasury shares did not affect retained earnings because the
reissuance price exceeds the cost.
2. A
Solution:
Total profit since incorporation 420,000
(130,000
Total cash dividends paid
)
Total value of property dividends distributed
(30,000)
Retained earnings to date 260,000
The excess proceeds on the sale of treasury shares are credited to

share premium.
3. A
Solution:
Outstandin

Issued g
Issued as of Dec. 31, 20x1
100,000 100,000
Treasury shares as of Dec. 31, 20x1
(5,000)
20x2 transactions:
May 3 - reissuance of treasury shares 1,000
Aug. 6 - issuance of new shares
10,000 10,000
Totals 106,000
204
110,000
Nov. 18 - 2-for-1 share split 2 2
Ending balances 212,000
220,000
4. A
Solution:
Outstanding shares - Dec. 31, 20x1 300,000
Jan. 31 - 10% stock dividend (300,000 x 10%) 30,000
June 30 - treasury stock acquisition
(100,000)
Aug. 1 - reissuance of treasury stock 50,000
Total 280,000
Nov. 30 - 2-for-1 stock split 2
Outstanding shares - Dec. 31, 20x2 560,000
5. B (100,000 x 2) x .50 = 100,000
6. B
Solution:
Total cash dividends declared 44,000
Dividends to preference sh. [(4,000 x 100 x 6%) + 12,000]
(36,000)
Dividends to ordinary sh. 8,000
7. C
Solution:
Total dividends declared 100,000
Allocation:
Basic allocation to preference shares: (30,000 x 10 x
5%) 15,000
Basic allocation to ordinary shares: (200,000 x 1 x
5%) 10,000
Excess subject to participation (100,000 – 15,000 –
10,000) 75,000
Participation of preference sh. (75,000 x 3/5) 45,000
Participation of ordinary sh. (75,000 x 2/5) 30,000
Balance -
Total dividends to ordinary shareholders = 10,000 + 30,000 = 40,000
8. A Although property dividends are accounted for at fair value,

their net effect on retained earnings is a decrease equal to the
205
carrying amount of the property dividends as at the declaration
date.
9. C (2.50 – 2) x 100,000 = 50,000
10. B
Solution:
10% ('small' dividend) - at fair value
15,000
28% ('large' dividend) - at par value
30,800
Total debit to retained earnings 45,800
11. A stock dividend payable is not a liability.
12. C
Share splits do not affect total shareholders’ equity. The aggregate
par value of outstanding shares remains the same after a share split.
The entry to record the share split is as follows:
Apr. Common stock (old) (50,000 sh. x ₱20) 1,000,000
27,
Common stock (new) (100,000 sh. x 1,000,00
20x1
₱10) 0
13. B Share premium is not affected by share splits.
14. C
Solution:
The entries to record the quasi-reorganization are as follows:
Jan. Share capital [(₱30 – ₱5) x 10,000 sh.] 250,000
2,
20x
2 to record the reduction of par value
Jan. Share premium 210,000
2,
Retained earnings
20x
2 to wipe out the deficit 210,000
Share premium - Dec. 31, 20x1 150,000

Credit (see journal entries above) 250,000
Debit (see journal entries above) (210,000)

Share premium after quasi-reorganization 190,000
206
11 21
1. A B D
. .
12 22
2. A C A
. .
13 23
3. C B D
. .
14 24
4. B B D
. .
15 25
5. C A A
. .
16 26
6. A A C
. .
17 27
7. B B D
. .
18 28
8. B A A
. .
19 29
9. D C C
. .
10 20 30
C B C
. . .
Exercises
1. Solution:
Cash dividends payable is computed as follows:
Shares issued (P1,600,000 ÷ P100 par) 16,000
Shares subscribed (P440,000 ÷ P100 par) 4,400
Treasury shares (P288,000 ÷ P120 cost) ( 2,400)
Outstanding shares 18,000
Multiply by: Dividends per share 50
Total cash dividends declared 900,000
The pertinent entries are:

April 1, 20x1 Retained earnings or 900,00
(Date of Dividends* 0
declaration) Cash dividends payable** 900,00
0
April 15, 20x1
(Date of No entry
record)
May 1, 20x1 Cash dividends payable 900,00
(Date of Cash in bank 0 900,00
distribution) 0
207
2. Solution:
Scrip dividends payable is computed as follows:
Multiply by: Par value per share 100
Aggregate par value of outstanding shares 1,800,000
Multiply by: Dividends as percentage of par value 50%
Total scrip dividends declared 900,000
Pertinent entries are:
April 1, 20x1 Retained earnings or 900,00
(Date of Dividends 0
declaration) Scrip dividends payable 900,00
0
April 15, 20x1
(Date of record) No entry
Sept 30, 20x1 Scrip dividends payable 900,00

(Date of Interest expense 0
distribution) (900,000 x 10% x 6/12) 45,000
Cash in bank 945,00
0
3. Solutions:
The entries on July 1, 20x1 are as follows:
July Retained earnings 1,600,00
1,
Property dividends payable 0 1,600,00
20x
1 to record declaration of property 0
dividends
July Non-current asset held for
1,
distribution 1,600,00
20x
1 to owners 0
Impairment loss 400,000 2,000,00
Investment in associate 0
to record reclassification of
investment in shares declared as
property dividends
The entries on Dec. 31, 20x1 are as follows:

Dec. Retained earnings 600,00
31,
Property dividends payable 0 600,000
20x1
(2.2M – 1.6M)
to record adjustment of dividend
payable for change in fair value of non-
cash assets
208
Dec. Non-current asset held for distribution 400,00
31,
to owners 0
20x1
Gain on impairment recovery 400,000
to recognize gain on impairment
recovery
The entries on Feb. 1, 20x2 are as follows:

Feb Property dividends payable 300,000
. 1,
Retained earnings (2.2M – 1.9M) 300,000
20x
to adjust dividends payable for fair
2
value change as of settlement date
Feb Property dividends payable 1,900,00
. 1,
Loss on distribution of property 0
20x
2 dividend 100,000
Non-current asset held for 2,000,00
distribution to owners 0
to record distribution of property
dividends
4. Solution:
1, Property dividends payable 0 1,600,00
20x to record declaration of property 0
1 dividends
July Impairment loss 400,000
1, Inventory 400,000
20x to record write-down of inventory
1 to NRV

July Retained earnings (2.2M – 1.6M) 600,000
31, Property dividends payable 600,000
20x1 to adjust dividends payable
for fair value change as of settlement
date
July Property dividends payable 2,200,00
31, Inventory 0 1,600,00
20x1 Gain on distribution of property 0
dividend 600,000
dividends
5. Solution:
1, Property dividends payable 0 2,200,00
209
20x1 to record declaration of 0
property dividends

July Retained earnings (2.4M – 2.2M) 200,000
31, Property dividends payable 200,000
20x1 to adjust dividends payable for fair
value change as of settlement date
July Property dividends payable 2,400,00
31, Inventory 0 2,000,00
20x1 Gain on distribution of property 0
dividend 400,000
dividends
6. Solution:
The fair values of each alternative adjusted for associated probability
is computed as follows:
Dividends
Alternatives Fair value Probability payable
Cash dividends 2,000,000 60% 1,200,000
Property dividends 1,600,000 40% 640,000

100% 1,840,000
The entries on April 1, 20x1:

Apri Retained earnings 1,840,00
l 1, Cash dividends payable 0 1,200,00
20x Property dividends payable 0
1 to record declaration of dividends 640,000
Apri Unrealized loss on fair value change 400,000
l 1, – P/L
20x Held for trading securities 400,000
1 to recognize change in fair value of
investment
The fair values of each alternative are again adjusted on April 30,
20x1 as follows:
Dividends
Alternatives Fair value Settlement payable
Cash dividends 2,000,000 30% 600,000
Property dividends 2,200,000 70% 1,540,000

100% 2,140,000
210
The entries on April 30, 20x1:
Apri Retained earnings 300,000
l 30, Cash dividends payable (1.2M – 600,000
20x 600K) 900,000
1 Property dividends payable
(1.540M – 640K)
to adjust dividends payable for fair
value changes as of settlement date
Apri Cash dividends payable 600,000
l 30, Property dividends payable 1,540,00
20x Cash in bank 0 600,000
1 Held for trading securities 1,120,00
(800K x 70%) 0
Gain on distribution of property
dividends 420,000
to record settlement of dividends
7. Solution:
The share dividends declared is determined as “small” or “large” as
follows:
Share dividends declared – “1 sh. for every 10 shares held” 1/10
Percentage of share dividends declared 10%
The share dividends declared is considered “small” because it is less

than 20%.Thus, fair value accounting is appropriate.
Share dividends distributable is computed as follows:

Multiply by: Dividends declared 1/10
Number of shares declared as dividends 1,800
Total share dividends distributable 180,000

April 1, Retained earnings 216,00
20x1 (1,800 sh. x P120) 0
(Date of Share dividends 180,00
declaration distributable 0
) Share premium
36,000
April 15,
20x1
(Date of
No entry
record)
211
May 1, 20x1 Share dividends distributable 180,00
(Date of Share capital 0 180,00
distributio 0
n)
8. Solution:
The share dividends declared is determined as “small” or “large” as
follows:
Share dividends declared – “1 sh. for every 5 shares held” 1/5
Percentage of share dividends declared 20%
The share dividends declared is considered “large” because it meets

the threshold of “20% or more.” Thus, fair value accounting is not
appropriate.

Number of dividends declared 3,600

April 1, 20x1 Retained earnings (3,600 x 360,00
(Date of P100) 0 360,00
declaration) Share dividends 0
distributable
April 15,
20x1
(Date of
No entry
record)
(Date of Share capital 0 360,00
distribution 0
)
9. Solutions:
April 1, Retained earnings (2M x 20%) 400,00
20x1 Share dividends distributable 0 400,00
(Date of 0
declaration
)
April 15,
20x1
(Date of
No entry
record)
May 1, Share dividends distributable 400,00
20x1 Share capital (3,400 x P100) 0 340,00
212
(Date of Share premium – warrants 0
distribution outstanding (600 x P100) 60,000
)
June 1, Share premium – warrants 50,000

20x1 outstanding 50,00
Share capital (500 x P100) 0
to record the issuance of the 500 full
shares
June 1, Share premium – warrants 10,000
20x1 outstanding 10,00
Share premium (100 x P100) 0
to transfer directly within equity the
share premium arising from expired warrants
10. Solution:
Shares issued (P1.6M ÷ P100 par) 16,000
Number of treasury shares declared as dividends 1,800
Multiply by: Cost per share 120

April 1, 20x1 Retained earnings (1,800 x 216,00
(Date of P120) 0 216,00
declaration Share dividends 0
) distributable
April 15,
20x1
(Date of
No entry
record)
(Date of Treasury shares 0 216,00
distribution)
0
May 1, 20x1 Treasury shares – 216,00
appropriated 0 216,00
Treasury shares – 0
unrestricted
to reverse appropriation on
treasury shares issued as dividends
11. Solutions:
Requirement (a) – Preference share is noncumulative
213
3,600,00
Total dividends declared 0
Allocation:
400,00
Allocation to preference shares: (4M par x 10% x 1 yr.) 0
3,200,00
Excess allocated to ordinary shares: (1.8M - 200,000) 0
Balance -
Requirement (b) – Preference share is cumulative

Total dividends declared 3,600,000
Allocation:
1,200,00
Allocation to preference shares: (4M par x 10% x 3 yrs.) 0
Excess allocated to ordinary shares: (1.8M - 200,000) 2,400,000
Balance -
Requirement (c) – Preference share is noncumulative and fully

participating
Allocation:
Basic allocation to preference shares:
(4M par x 10% x 1 yr.) 400,000
Basic allocation to ordinary shares: 1,600,00
(16M par x 10% x 1 yr.) 0
1,600,00
Excess subject to participation (3.6M - .4 - 1.6) 0
Participation of preference shares
(1,600,000 x 4M par/ 20M par) 320,000
Participation of ordinary shares 1,280,00
(1,600,000 x 16M par/ 20M par) 0
Balance -
The allocated amounts are reconciled with the total dividends

declared as follows:
3,600,00
Total dividends declared 0
Total dividends allocated as:
Allocation to preference shares:
(400K basic + 320K participation) 720,000
Allocation to ordinary shares: 2,880,00
(1.6M basic + 1.28M participation) 0
3,600,00
As allocated 0
214
Requirement (d) – Preference share is cumulative and fully
participating
Allocation:
Basic allocation to preference shares: 1,200,00
(4M par x 10% x 3 yrs.) 0
(16M par x 10% x 1 yr.) 0
Excess subject to participation 800,000
Participation of preference shares (800,000 x 4M/20M) 160,000
Participation of ordinary shares (800,000 x 16M/20M) 640,000
Balance -

Allocation to preference shares: 1,360,00
(1.2M basic + 160K participation) 0
Allocation to ordinary shares:
(1.6M basic + 640K participation) 2,240,000
As allocated 3,600,000
Requirement (e) – Preference share is cumulative and

participating up to 16%
Allocation:
Basic allocation to preference shares: 1,200,00
(4M par x 10% x 3 yrs.) 0
(16M par x 10% x 1 yr.) 0
Excess subject to participation 800,000
Participation of preference shares [4M par x (16% -
10%)*] 240,000
Excess allocated to ordinary shares (800,000 - 240,000) 560,000
Balance -

Allocation to preference shares: 1,440,00
(1.2M basic + 240K participation) 0
Allocation to ordinary shares:
(1.6M basic + 560K participation) 2,160,000
215
12. Solution:
Allocation:
Basic allocation to 10% preference shares:
(4M par x 10% x 3 yrs.) 1,200,000
Basic allocation to 12% preference shares:
(12M par x 12% x 1 yr.) 1,440,000
(16M par x 10% x 1 yr.)* 0
Excess subject to participation 3,760,000
Participation of 10% preference shares
(3,760,000 x 2M/16M) 470,000
Participation of 12% preference shares 1,410,00
(3,760,000 x 6M/16M) 0
1,880,00
Participation of ordinary shares (3,760,000 x 8M/16M) 0
Balance -


Allocation to 10% preference shares: (1.2M + 470K) 1,670,000
Allocation to 12% preference shares: (1.440M +1.410M) 2,850,000
Allocation to ordinary shares: (1.6M + 1.880M) 3,480,000
13. Solution:
Dat Share capital 2,000,00
e Share premium 0
Share capital (20,000 x P80) 400,000 1,600,00
Share premium – 0
recapitalization 800,000
14. Solution:
1 Building (P3M – P1.6M) 1,400,00
Revaluation surplus 0 1,400,00
to record revaluation of building 0
216
2 Retained earnings 1,200,00
Receivables (4,000,000 x 30%) 0 1,200,00
to record write-off of receivables 0
3 Retained earnings 1,100,00
Inventory (3.1M – 2M) 0 1,100,00
to record write-down of 0
inventory
4 Retained earnings 100,000
Goodwill 100,000
to record write-down of goodwill
5 Retained earnings 60,000
Estimated liability on pending 60,000
lawsuit
to recognize provision for
probable loss on pending lawsuit
6 Share capital 5,000,00
Share premium 0 5,000,00
to record recapitalization 0
effected through reduction of share
capital
7 Revaluation surplus 1,400,00
Share premium 0
Retained earnings 5,000,00 6,400,00
to wipe out deficit 0 0
15. Solutions:
Requirement (a): Shareholders’ equity on July 1, 20x1
The recapitalization on July 1, 20x1 are recorded as follows:
July Ordinary share capital – old 4,000,00
1, Ordinary share capital – new 0 2,000,00
20x (40,000 ÷ 2) x P100 0
1 Share premium
to record recapitalization 2,000,00
0
July Retained earnings (20,000 x ½ x P100) 1,000,00
1, Ordinary share capital – new 0 1,000,00
20x to record ordinary share 0
1 dividends issued to preference
shareholders
July Share premium 2,000,00
1, Retained earnings 0 2,000,00
20x to wipe out deficit 0
1
The number of outstanding ordinary shares after the recapitalization

is computed as follows:
217
New shares issued to replace old shares recalled
[40,000 old shares x (1 new share / 2 old shares)] 20,000
New shares issued as share dividend to preference
shareholders (20,000 preference shares outstanding
x ½ new ordinary share) 10,000
Outstanding ordinary shares – July 1, 20x1 30,000
The shareholders’ equity of ABC on July 1, 20x1 would appear as
follows:
10% Preference shares, P100 par, cumulative, 20,000
shares
issued and outstanding 2,000,000
Ordinary shares, P100 par, 30,000 shares issued and
outstanding 3,000,000
Share premium -
Retained earnings -
5,000,00
Total shareholders' equity 0
Notice that the total of shareholders’ equity is not affected by the

recapitalization.
Requirement (b): Shareholders’ equity on December 31, 20x1

The transactions for the remainder of the year are recorded as
follows:
Sep Preference shares 1,000,00
t 30, (10,000 x P100 par value) 0
20x
1
Retained earnings
Cash in bank 100,000 1,100,00
[10,000 x (P100 + P10 premium)] 0
to record the recall and
retirement of 5,000 preference shares
Sep Retained earnings 25,000
t 30,
Cash in bank 25,000
20x
1
(10,000 x P100 x 10% x 3/12)
to record 3-month dividends paid
on preference shares retired
Oct. Cash on hand (6,000 x P150) 900,000
31,
Ordinary share capital – new 600,000
20x
(6,000 x P100)
1
to record issuance of ordinary
shares
Dec Income summary 2,200,00
. 31,
Retained earnings 0 2,200,00
20x
1 to close profit to retained 0
earnings
Dec Retained earnings 2,000,00
218
. 31, Retained earnings – 0 2,000,00
20x
appropriated* 0
1
to restrict retained earnings for
the deficit wiped out during quasi-
reorganization
Dec Retained earnings** 68,000
. 31,
Dividends payable – preference 50,000
20x
1 shares
Dividends payable – ordinary 18,000
shares
to record dividend declaration
*Retained earnings after quasi-reorganization is restricted to the

extent of the deficit wiped out during quasi-reorganization (P1M
deficit + P1M liquidation of dividend in arrears). See journal entry on
July 1, 20x1.
**The dividends are computed as follows:

Number of preference shares outstanding as of July 1, 20x1 20,000
Number of preference shares recalled on
September 30, 20x1 (10,000)
Number of preference shares outstanding as of
December 31, 20x1 10,000
Aggregate par value of outstanding preference shares 1,000,000
Multiply by: Preference dividend rate 10%
Annual preference dividend 100,000
Multiply by: 6/12
Semi-annual preference share dividend 50,000
Number of ordinary shares outstanding after recapitalization

on July 1, 20x1 (see previous computation) 30,000
Number of ordinary shares issued on October 31, 20x1 6,000
Number of ordinary shares outstanding as of
December 31, 20x1 36,000
Multiply by: Declared cash dividends per share 0.50
Ordinary share dividend 18,000
The shareholders’ equity on December 31, 20x1 would appear as

follows:
10% Preference shares, P100 par, cumulative, 10,000
shares
1,000,00
issued and outstanding 0
Ordinary shares, P100 par, 15,000 shares issued and
outstanding 3,600,000
219
Retained earnings - appropriated 2,000,000
Retained earnings - unrestricted 7,000
220
Chapter 33 – Share-based Payments (Part 1)
1. C 6. B
2. C 7. C
3. A 8. C
4. B 9. C
5. C 10. B

Solutions:
1. A (140 – 5) x 1,000 = 135,000; The ₱160 per hour billing price is
not deemed the fair value of the legal services received.
2. D (1,000 x 7) = 7,000. In the absence of evidence to the contrary,

it shall be presumed that share options vest immediately.
3. B (3,000 shares x ₱8 fair value per option x ½) = 12,000
4. A (12,000 x 70%) = 8,400
5. C (350,000 employee withholdings x 2) = 700,000 employer’s

contribution
6. C (40,000 x 10 x 96% x 1/2) = 192,000
7. A 45,000 cash contribution + (3,000 x 18) fair value of stock

contribution = 99,000

11 21 41
1. A A A 31. D A 51. A
. . .
12 22 42
2. C B C 32. B C 52. A
. . .
13 23 43
3. D D A 33. C C 53. B
. . .
14 24 44
4. C A C 34. C C 54. C
. . .
15 25 45
5. B C A 35. C C 55. B
. . .
16 26 46
6. C B A 36. A C
. . .
221
17 27 47
7. A B B 37. A C
. . .
18 28 48
8. C B D 38. C B
. . .
19 29 49
9. A D B 39. C B
. . .
10 20 30 50
B C C 40. C C
. . . .
Exercises
1. Solution:
Dec. Building 3,000,000
31,
Subscribed share capital 2,000,00
20x
1
(10,000 x P200) 0
Share premium (squeeze)
1,000,00
0
Jan. Subscribed share capital 12000,00
31,
Share capital 0 2,000,00
20x
1 0
2. Solutions:
Salaries expense is computed as follows:
Jan. Fair value of share options at grant date:
1, (10,000 share options x P30 per sh. option) 300,000
20x Multiply by: Vesting period passed over Total vesting
1 period N/A
Salaries expense for current year - 20x1 300,000
The entry to record the share options on grant date is:

Jan. Salaries expense – share options 300,00
1, (10,000 x P30) 0
20x1
Share premium – share options 300,00
outstanding 0
The entry to record the exercise of the share options is:

July Cash on hand (10,000 x P220) 2,200,00
1,
Share capital (10,000 x P200) 0 2,000,00
20x
1 Share premium 0
200,000
July Share premium – share options 300,000
1,
outstanding
20x
1 Share premium 300,000
222
3. Solutions:
Salaries expenses are computed as follows:
Dec Number of share options granted per employee 1,000
. Multiply by: # of employees expected to remain in
31, service 100
20x
Total share options expected to vest 100,000
1
Multiply by: Fair value per share option at grant date 30
Fair value of share options at grant date 3,000,000
Multiply by: Vesting period passed over Total vesting 1 yr. /3
period yrs.
Cumulative salaries expense to date 1,000,000
Salaries expense recognized in previous periods -
1,000,00
Salaries expense for current year - 20x1 0
Dec Fair value of share options at grant date

. 31, (100 x 1,000 x 30) 3,000,000
2 period 2 yrs. /3 yrs.
Salaries expense recognized in previous periods (1,000,0
(1M in 20x1) 00)
Salaries expense for current year - 20x2 1,000,000

. 31, (100 x 1,000 x 30) 3,000,000
3 period 3 yrs. /3 yrs.
Salaries expense recognized in previous periods
(1M + 1M) (2,000,000)
1,

Memo entry
Jan. (“Granted 1,000 share options to 100 key -
1, employees on Jan. 1, 20x1. Fair value -
20x per share option on Jan. 1, 20x1 is
1 P30.”)
Dec Salaries expense – share options 1,000,00

. 31, [(100 x 1,000 x P30 x 1/3) 0
20x Share premium – share options
1 1,000,00
outstanding
0
. 31,
223
20x [(100 x 1,000 x 30 x 2/3) – 1M] 0
2 Share premium – share options 1,000,00
outstanding 0
. 31, [(10 x 1,000 x 30 x 3/3) – 2M] 0
20x Share premium – share options 1,000,00
3 outstanding 0
4. Solutions:
. (100 employees - 20) x 1,000 sh. options x P30 per sh.
31, option) 2,400,000
1 period 1 yr. /3 yrs.
Cumulative salaries expense to date 800,000

. [(100 – 20) x 1,000 x 30] 2,400,000
31, Multiply by: Vesting period passed over Total vesting
20x period 2 yrs. /3 yrs.
2
1,600,00
Cumulative salaries expense to date 0
Salaries expense recognized in previous periods (800,000)

. [(100 – 20) x 1,000 x 30] 2,400,000
31,
3 period 3yrs. /3yrs.
Salaries expense recognized in previous periods (1,600,000
(800K + 800K) )

Jan.
1, Memo entry
20x1
Dec. Salaries expense – share options 800,00
31, [(100 – 20) x 1,000 x P30 x 1/3] 0
20x1 Share premium – share options 800,00
outstanding 0
31, [(100 – 20) x 1,000 x P30 x 2/3] – 800,000 0
20x2
224
outstanding 0
31, [(100 – 20) x 1,000 x P30 x 3/3] – 1,600,000 0
outstanding 0
5. Solutions:
.
31, (100 employees - 15) x 1,000 sh. options x P30 per option) 2,550,000
1 period 1/3
Dec Fair value of share options at grant date 2,640,00

. [(100-12) x 1,000 x 30] 0
20x
period 2/3
2
1,760,00
Cumulative salaries expense to date 0
910,00

. [(100-10) x 1,000 x 30] 2,700,000
20x period 3/3
3
Salaries expense recognized in previous periods (1,760,000)

Jan.
1, Memo entry
20x1
31, [(100 – 15) x 1,000 x P30 x 1/3] 0
outstanding 0
31, [(100 – 12) x 1,000 x P30 x 2/3] – 850,000 0
outstanding 0
225
31, [(100 – 10) x 1,000 x P30 x 3/3] – 1,760,000 0
outstanding 0
6. Solution:
Dec. Fair value of share options at grant date

31, [(100 employees - 20) x 1,000 x P30 per sh. option] 2,400,000
20x1 Multiply by: Vesting period passed over Total vesting
period 1/3

31, [(100 - 20) x 1,000 x 30] 2,400,000
period 2/3

31, [100 x 1,000 x 30] 3,000,000
period 3/3
(1,600,000
Salaries expense recognized in previous periods )
1,400,00

Jan.
1,
20x Memo entry
1
Dec Salaries expense – share options 800,000
. 31, [(100 – 20) x 1,000 x P30 x 1/3]
20x Share premium – share options 800,000
1 outstanding
Dec Salaries expense – share options 800,000
. 31, [(100 – 20) x 1,000 x P30 x 1/3] – 800,000
20x Share premium – share options 800,000
2 outstanding
226
. 31, (100 x 1,000 x P30 x 3/3) – 1,600,000 0
20x Share premium – share options 1,400,00
3 outstanding 0
7. Solution:
Before vesting
11
Dec Market price per share on Dec. 31, 20x1 0
. 31,
20x Exercise price per share (100)
1 1
Intrinsic value per share - Dec. 31, 20x1 0
Multiply by: Number of share options expected to vest
(10 x 100 x 70%) 700
Intrinsic value of share options granted 7,000
Multiply by: Vesting pd. passed over Total vesting pd. 1/2
Dec. Market price per share on Dec. 31, 20x2 120

31,
20x2 Exercise price (100)
Intrinsic value per share - Dec. 31, 20x2 20
Multiply by: Number of share options that have
actually vested 600
Intrinsic value of share option granted 12,000
After vesting
Dec Change in intrinsic value of vested share options that were exercised
. during the yr.:
31,
20x [300 x (P150 – P120)] 9,000
3
Change in intrinsic value of vested share options that are not yet
exercised:
[300 x (P150 – P120)] 9,000
De Change in intrinsic value of vested share options that were

c. exercised during the yr.:
31,
20x [100 x (P124 – P150)] (2,600)
4
227
Change in intrinsic value of vested share options that are not yet
exercised:
[200 x (P124 – P150)] (5,200)
Salaries expense for current year - 20x4 (7,800)
De Change in intrinsic value of vested share options that were

c. exercised during the yr.:
31,
[200 x (P160–P124)] 7,200
20x
5 Salaries expense for current year - 20x5 7,200

Jan.
1, Memo entry
20x1
31, [(100 x 10 x 70%) x (P110 – P100) x 1/2)]
outstanding
31, [600 x (P120 – P100) x 2/2)] – 1,750
outstanding
31, [300 x (P150 – P120)] + [300 x (P150 – P120)]
outstanding
Dec. Share premium – share options outstanding 7,800
31, Gain on decline of intrinsic value 7,800
20x4 [100 x (P124 – P150)] + [200 x (P124 –
P150)]
31, [200 x (P160 – P124)]
outstanding
228
Chapter 34 – Share-based Payments (Part 2)
1. B
2. B
3. C
4. D
5. D

Solutions:
1. D (20,000 x 16 x1/2) = 160,000
2. B (20,000 x 18 x 2/2) = 360,000
3. C [20,000 x (₱45 - ₱30)] = 300,000
4. A 10,000 x (28 – 20) = 80,000

21
1. B 6. C 11. A 16. D A 26. A
.
22
2. C 7. B 12. C 17. C D 27. A
.
23
3. C 8. C 13. A 18. B A 28. A
.
24
4. D 9. A 14. C 19. C B 29. C
.
10 25
5. D A 15. B 20. A C 30. A
. .
31. B
Exercises
1. Solutions:
Dec Fair value of SARs at year end (900 x 24) 21,600
. 31,
20x Multiply by: Vesting pd. passed over Total vesting pd. 1/3
1 Cumulative balance of accrued liability to date 7,200
229
Dec Fair value of SARs at year end (800 x 30) 24,000
. 31,
2 16,00
Cumulative balance of accrued liability to date 0
Dec 24,00
. Fair value of SARs at year end (750 x 32) 0
31,
3 24,00
8,00

Memo entry
Jan. (“Granted 1,000 cash share appreciation -
1, rights ‘SARs’ to employees with the condition -
20x1 that the employees remain in service for the
next 3 years.”)
Dec. Salaries expense – SARs [900 x 24 x 1/3] 7,200
31, Accrued salaries payable 7,200
20x1
Dec. Salaries expense – SARs 8,800
31, [800 x 30 x 2/3] – 7,200 8,800
20x2 Accrued salaries payable
31, [750 x 32 x 3/3] – 16,000 8,000
20x3 Accrued salaries payable
Dec. Accrued salaries payable 24,000
31, Cash in bank (750 x 32) 24,000
20x3
2. Solution:
Dec Fair value of SARs at year end (300 - 21 - 36) x 100 x

. 31, 14.40 349,920
1 Cumulative balance of accrued liability to date 116,640
116,64
230
Dec Fair value of SARs at year end 372,00
. (300 - 21 - 24- 15) x 100 x 15.50 0
31, Multiply by: Vesting pd. passed over Total vesting pd. 2/3
20x 248,00
2 Cumulative balance of accrued liability to date 0
Cumulative balance of accrued liability as of Dec. 31, (116,640
20x1 )
De Salaries expense from SARs vested but not yet

c. exercised:
31, Fair value of SARs at year end (excluding SARs that were
20x
exercised)
3
(300 - 21 - 24 - 13 - 90) x 100 x 18.20 276,640
Multiply by: Vesting pd. passed over Total vesting pd. 3/3
276,64
Cumulative balance of accrued liability as of Dec. 31,
20x2 (248,000)
Salaries expense for current year - 20x3 - SARs
unexercised 28,640
Salaries expense from SARs exercised:

Intrinsic value of SARs exercised (90 x 100 x 15) 135,000
exercised 135,000
Total salaries expense for current year - 20x3 163,640
Dec Salaries expense from SARs vested but not yet

. exercised:
20x
exercised)
4
[(300 – 21 – 24 – 13 – 90 - 84) x 100 x 21.40 145,520
Cumulative balance of accrued liability to date 145,520
20x3 0)
Salaries expense for current year - 20x4 - SARs (131,12
unexercised 0)

Salaries expense for current year - 20x4 - SARs 168,00
exercised 0
231
36,88
Total salaries expense for current year - 20x4 0
De Salaries expense from SARs vested but not yet

c. exercised:
20x
exercised)
5
[(300 – 21 – 24 – 13 – 90 - 84 - 68) x 100 x 0 -
Cumulative balance of accrued liability to date -

20x4 0)
Salaries expense for current year - 20x5 - SARs (145,52
unexercised 0)

exercised 170,000
Total salaries expense for current year - 20x5 24,480

Jan.
1, Memo entry
20x1
31, [(300 – 21 – 36) x 100 x 14.40 x 1/3] 0
20x1 Accrued salaries payable 116,64
0
31, [(300 – 21 – 24 - 15) x 100 x 15.50 x 2/3] – 0
20x2 116,640
Accrued salaries payable 131,36
0
Salaries expense – SARs 28,640
[(300 - 21 - 24 - 13 - 90) x 100 x 18.20 x 3/3] -
Dec. 248,000
31, Accrued salaries payable 28,640
20x3 Salaries expense - SARs 135,00
Cash in bank (90 x 100 x 15) 0 135,00
0
Dec. Accrued salaries payable 131,12
31, Salaries expense – SARs 0 131,12
20x4 [(300 – 21 – 24 – 13 – 90 - 84) x 100 x
0
21.40] – 276,640
232
Salaries expense - SARs 168,00
Cash in bank (84 x 100 x 20) 0 168,00
0
Accrued salaries payable 145,52
(116,640 + 131,360 + 28,640 – 131,120) 0
31, 0
20x5
Salaries expense - SARs 170,00
Cash in bank (68 x 100 x 25) 0 170,00
0
3. Solution:
The fair value of the equity component is computed as follows:
Fair value of equipment received P240,000
Fair value of debt component on Jan. 1, 20x1
(10,000 sh. x P22) ( 220,000)
Fair value of equity component P 20,000
The entry to record the asset received is:

Jan. Equipment (fair value of asset 240,00
1, received) 0 220,00
20x1
Accounts payable 0
outstanding
4. Solution:
The liability component is remeasured to fair value as of settlement
date as follows:
Fair value of debt component, Dec. 31, 20x1
(10,000 sh. x P28) 280,000
Fair value of debt component, Jan. 1, 20x1
(10,000 sh. x P22) (220,000)
Loss on remeasurement of liability
(increase in liability) 60,000

Dec. Loss on remeasurement of liability 60,000
31, Accounts payable 60,000
20x1 to record remeasurement of
liability to its fair value on settlement date
Dec. Accounts payable (220,000 + 60,000) 280,00
31, Share capital (10,000 x P20 par value) 0 200,00
20x1
Share premium 0
to record issuance of equity 80,000
instrument
Dec. Share premium – share options 10,000
31,
233
20x1 outstanding
to transfer share premium from
share options directly within equity.
5. Solution:
Fair value of debt component, Dec. 31, 20x1
(10,000 sh. x P28) 280,000
Fair value of debt component, Jan. 1, 20x1
(10,000 sh. x P22) (220,000)
Loss on remeasurement of liability
(increase in liability) 60,000

Dec. Loss on remeasurement of liability 60,000
31, Accounts payable 60,000
20x1 to record remeasurement of
liability to its fair value on settlement date
Dec. Accounts payable (220,000 + 60,000) 280,00
31, Cash in bank (10,000 x 28) 0 280,00
20x1 to record settlement of account 0
Dec. Share premium – share options 20,000

31, outstanding
20x1
to transfer share premium from
share options directly within equity.
234
Chapter 35 – Book Value Per Share
Solutions:
1. B
Solution:
Total shareholders' equity 160,000
Preference shareholders' equity:
Par value 50,000
Dividends in arrears (50,000 x 8%) 4,000 (54,000)
Ordinary shareholders' equity 106,000
Divide by: Ordinary shares outstanding* 8,900
Book value per share (Ordinary shares) 11.91
* (₱90,000 ÷ ₱10 par) – 100 treasury shares = 8,900 shares
2. D
Solution:
Liquidation value (250K par x 50K
premium) 300,000
Dividends in arrears 25,000 (325,000)
Ordinary shareholders' equity 700,000
Divide by: Ordinary shares outstanding (350K ÷
₱3.50) 100,000
3. A
Solution:
Liquidation value (50,000 x ₱110) 5,500,000
(5,800,000
Dividends in arrears (5,000,000 x 6%) 300,000 )
Ordinary shareholders' equity 2,200,000
Divide by: Ordinary shares outstanding (350K ÷
₱3.50) 400,000

1
A 6. D C
. 11.
235
2
A 7. B
.
3
B 8. D
.
4
D 9. B
.
5
B 10. A
.
Chapter 36 – Earnings Per Share
11
1. B 6. C D
.
12
2. A 7. C C
.
13
3. B 8. B B
.
14
4. C 9. D B
.
10 15
5. B B A
. .
Solutions:
1. B
Solution:
Profit or loss less Preferred dividends
Basic
= Weighted average number of outstanding ordinary
EPS
shares
Basic 1,000,000 – (10,000 x 5% x ₱100)
=
EPS 100,000
Basic EPS = (1,000,000 – 50,000) ÷ 100,000 = 9.50
2. A
Solution:
Basic
EPS
shares
Basic 960,000 – 100,000
=
EPS (200,000 x 110%)
Basic EPS = 860,000 ÷ 220,000 = 3.91
3. B
Date No. of shares Months Weighted
236
outstanding average
(a) (b) (c) = (a) x (b)
Jan. 1 20,000 + 20,000 12/12 40,000
Apr. 1 N/A (effect is on Jan. 1) - -
July 1 6/12
10,000 5,000
Weighted average number of ordinary
shares 45,000
4. C
Solution:
(30,000 + 3,000) x
1/1/x8 Shares outstanding
12/12 33,000
2/1/x8 10% share dividend see effect on Jan. 1
3/1/x8 Business
(9,000 x 10/12)
combination 7,500
7/1/x8 Issued for cash (8,000 x 6/12) 4,000
44,50
Weighted average shares
0
5. B
Solution:
The weighted average outstanding shares are computed as follows:
Outstandin Months Weighted
g shares outstanding average
Jan. 1,
20x3 20,000.00 12/12 20,000
May 1,
20x3 10,500.00 8/12 7,000
27,000

Basic
EPS
shares
Basic 96,700 – (10,000 x ₱4)
=
EPS 27,000
Basic EPS = 56,700 ÷ 27,000 = 2.10
6. C
Solution:
Profit or loss plus After tax interest expense on
convertible bonds
Diluted
EPS
shares plus Incremental shares arising from the
assumed conversion or exercise of dilutive potential
237
ordinary shares
Numerator on Diluted EPS = 900,000 + 0 = 900,000
7. C
Solution:
(600,000 x 600,00
Jan. 1, 20x3 Outstanding shares 12/12) 0
135,00
Apr. 1, 20x3 Additional shares issued (180,000 x 9/12) 0
(150,000 x 150,00
Incremental shares from conv. bonds 12/12) 0
Weighted average outstanding 885,00
shares 0
8. B
Solution:
convertible bonds
Diluted Weighted average number of outstanding ordinary
EPS
=
ordinary shares
Diluted 840,000 + 0
EPS
=
200,000 + (20,000 x 5)
Diluted EPS = 840,000 ÷ 300,000 = 2.80
9. D
Solution:
convertible bonds
Diluted Weighted average number of outstanding ordinary
EPS
=
ordinary shares
Diluted 1,000 + (10,000 x 4% x 50%)
EPS
=
1,000 + 1,000
Diluted EPS = 1,200 ÷ 2,000 = 0.60
10. B
Solution:
Diluted
= convertible bonds
EPS
Weighted average number of outstanding ordinary
238
ordinary shares
Diluted 35,000 + (7,000 x 70%)
EPS
=
10,000 + (20 x 200)
Diluted EPS = 39,900 ÷ 14,000 = 2.85
11. D
Solution:
Option shares 9,000
Multiply by: Total exercise price 7
Proceeds from assumed exercise of options 63,000
Divide by: Average market price 9
7,00
Treasury shares assumed to have been purchased
0
Option shares 9,000

(7,000
Treasury shares assumed to have been purchased )
Incremental shares 2,000
Add: Actual shares outstanding 50,000
52,00
Total weighted average shares outstanding 0
12. C
Solution:
10,00
Option shares
0
Multiply by: Total exercise price 10
Proceeds from assumed exercise of options 100,000
4,00
Treasury shares assumed to have been purchased
0
Option shares 10,000

Treasury shares assumed to have been
purchased (4,000)
Add: Actual shares outstanding 100,000
106,00
Total weighted average shares outstanding 0
13. B
Solution:
239
The multiple potential ordinary shares are ranked in accordance with
their dilutive effect as follows:
Increment Incremental Incrementa Ra
Potential ordinary shares
al earnings shares l EPS nk
a b c=a÷b
a. Convertible PS 30,000 20,000 1.50 1st
(₱3 x 10,000); (20,000)
b. Convertible bonds 56,000 30,000 1.87 2n
(1,000,000 x 8% x 70%); d
(30,000)
Diluted EPS is calculated by gradually considering the potential

ordinary shares starting with the first in rank as shown below:
Ordinary
Profit shares EPS
a b c=a÷b
Basic EPS from
continuing operations 820,000* 110,000 7.45
Convertible PS - (1st) 30,000 20,000
Diluted EPS #1 850,000 130,000 6.54 Dilutive
Convertible Bonds -
(2nd) 56,000 30,000
* Numerator for basic EPS, net of preferred dividends: (850,000 – 30,000) =

820,000.
14. B
Solution:
The multiple potential ordinary shares are ranked in accordance with
their dilutive effect as follows:
Increment Incremental Incrementa Ra
Potential ordinary shares
al earnings shares l EPS nk
a b c=a÷b
a. Convertible PS 60,000 10,000 6.00 2n
d
(₱6.00 x 10,000); (10,000)
st
b. Convertible bonds 45,000 30,000 1.50 1
(1,000,000 x 9% x 50%);
(30,000)
Diluted EPS is calculated by gradually considering the potential

ordinary shares starting with the first in rank as shown below:
Ordinary
Profit shares EPS
a b c=a÷b
Basic EPS from
continuing operations 425,000* 90,000 4.83
240
Convertible Bonds -
(1st) 45,000 30,000
Convertible PS - (2nd) 60,000 10,000
Anti-
Diluted EPS #2 530,000 130,000 4.08 dilutive
* Numerator for basic EPS, net of preferred dividends: (485,000 – 60,000) =

425,000.
15. A The contingent shares are ignored because the condition is

not met.

11 21 41 51
1. B D A
. . 31. B . B . B
12 22 42 52
2. A A A
. . 32. C . B . A
13 23 43 53
3. D A B
. . 33. B . B . B
14 24 44 54
4. A C D
. . 34. B . B . C
15 25 45 55
5. B B B
. . 35. A . B . D
16 26 46 56
6. A C C
. . 36. D . A . D
17 27 47 57
7. A B D
. . 37. A . A . A
18 28 48 58
8. C D C
. . 38. D . C . D
19 29 49
9. D A A
. . 39. D . D
10 20 30 50
B A B
. . . 40. D . D
Exercises
1. Solution:
The adjusted profit for Basic EPS computation is determined as
follows:
Profit after tax before adjustment for preferred dividends 2,400,000
One-year cumulative preferred dividends (P1M x 6%) ( 60,000)
Adjusted profit 2,340,000
241
Basic EPS is computed as follows:
Basic EPS = 2,340,000 ÷ 200,000
Basic EPS = 11.70
2. Solution:
Profit after tax before adjustment for preferred 2,000,00
dividends 0
Dividend on cumulative preference shares
(200,000
(current year only) - (10,000 x P200 x 10%) )
Dividend on non-cumulative preference shares
(declared for the year only) (50,000)
1,750,00
Profit or loss for basic EPS computation 0

Basic EPS = 1,750,000 ÷ 11,000
Basic EPS = 159.09
3. Solution:
Profit for the year 2,400,000
Allocation of basic dividends:
Basic allocation to preference shares: (P1M par x
10%) 100,000
Basic allocation to ordinary shares: (P2M par x 10%) 200,000
Excess subject to participation 2,100,000
Participation of preference shares (2.1M x 1M/3M) 700,000
Participation of ordinary shares (2.1M x 2M/3M) 1,400,000
Balance -
Basic earnings per share is computed as follows:

Preference Ordinary
shares shares
Allocation of profit:
(100,000 + 700,000) 800,000
(200,000 + 1,400,000) 1,600,000
Total allocated earnings 800,000 1,600,000
Outstanding shares 50,000 100,000
Basic EPS 16.00 16.00
4. Solutions:
The weighted average number of outstanding shares is computed as
follows:
242
Months Weighted
Date No. of shares outstanding average
(a) (b) (c) = (a) x (b)
Jan. 400,000 x 110% x
1 2 12/12 880,000
May
1 (24,000) x 2 8/12 (32,000)
June
1 120,000 x 2 7/12 140,000
Aug.
1 60,000 x 2 5/12 50,000
Dec.
1 12,000 1/12 1,000
shares 1,039,000
The basic EPS is computed as follows:

Basic EPS = Profit or loss less Preferred dividends ÷ Weighted
average outstanding ordinary shares
Basic EPS = 11,429,000 ÷ 519,500
Basic EPS = 22
5. Solution:
The weighted average number of outstanding shares are computed
as follows:
Mos. Weighted
(a) (b) (c) = (a) x (b)
200,000 x 110% x
Jan. 1, 20x1 2 12/12 440,000

shares - 20x1 440,000
Mos. Weighted
(a) (b) (c) = (a) x (b)
Jan. 1,
20x2 200,000 x 110% x 2 12/12 440,000
July 1,
20x2 20,000 x 2 6/12 20,000
shares - 20x2 460,000
The basic EPS to be presented in the comparative income statements

are computed as follows:
243
20x2 20x1
18,500,00 14,400,00
Profit after tax 0 0
Adjusted weighted ave. no. of
outstanding shares 230,000 220,000
Basic EPS 80.43 65.45
6. Solutions:
The adjustment factor to be used in calculating the weighted
average number of shares outstanding is computed as follows:
Fair value of share right-on - Subscription

Value of 1
= price
right
Number of rights to purchase one share + 1
Value of 1 right = (220 – 100) ÷ (5 + 1)
Value of 1 right = 20
Fair value of shares selling right-on 220

Value of 1 right ( 20)
Theoretical ex-rights fair value per share 200
Adjustment factor = 220/200
Basic earnings per share are computed as follows:

Year 20x0
Divide by: Weighted average # of outstanding shares
(100,000 x 220/200) 110,000
Basic earnings per share – 20x0 16.36
Year 20x1
The weighted average number of ordinary shares for basic earnings
per share computation in 20x1 is determined as follows:
January 1 Ordinary shares outstanding
(100K x 220/200 x 3/12) 27,500
April 1 Outstanding shares after exercise of rights
(120K* x 9/12) 90,000
Weighted average # of outstanding ordinary shares 117,500
*The outstanding shares after the exercise of rights are computed as

follows:
Ordinary shares before exercise of rights 100,000
Ordinary shares issued on the exercise of rights
(100,000 rights ÷ 5 rights to purchase one share) 20,000
Outstanding shares after exercise of rights 120,000
244
(27,500 + 90,000) 117,500
Year 20x2
(100,000 + 20,000) 120,000
7. Solutions:
Requirement (a): Basic earnings per share
The adjusted profit for Basic EPS computation is determined as
follows:
Profit after tax before adjustment for preferred
dividends 2,400,000
One-year cumulative preferred dividends
(P1,000,000 x 6%) ( 60,000)
Adjusted profit 2,340,000

Basic EPS = 2,340,000 ÷ 200,000
Basic EPS = 11.70
Requirement (b): Diluted earnings per share

The denominator on the diluted EPS formula is computed as follows:
Weighted average number of outstanding ordinary
Shares 200,000
Incremental shares (50,000 x 2) 100,000
Denominator for diluted EPS computation 300,000
Diluted EPS is computed as follows:

Diluted EPS = 2,400,000 ÷ 300,000
Diluted EPS = 8.00
8. Solutions:
Basic EPS = 2,400,000 ÷ 200,000
Basic EPS = 12.00

The after tax interest expense is computed as follows:
Interest expense (P8M x 10%) 800,000
Income tax benefit of the interest expense (800,000 x 30%) (240,000)
245
After tax interest expense 560,000
The denominator on the diluted EPS formula is computed as follows:

Weighted average number of outstanding ordinary shares 200,000
Incremental shares
(P8M bonds ÷ P1,000 bonds) x 30 ordinary shares 240,000
Denominator for diluted EPS computation 440,000

Diluted EPS = (2,400,000 + 560,000) ÷ (440,000)
Diluted EPS = 6.73
9. Solutions:
The weighted average number of outstanding ordinary shares is
January 1, 20x1 (200,000 x 12/12) 200,000
October 1, 20x1 (100,000 x 3/12) 25,000
Weighted ave. number of outstanding ordinary shares 225,000
Basic EPS = 2,400,000 ÷ 225,000

Basic EPS = 10.67

After tax interest expense is computed as follows:
Bonds payable (10,000 x P1,000) 10,000,000
Multiply by: Interest rate 10%
Total 1,000,000
Multiply by: Months outstanding 9/12
Interest expense before income tax 750,000
Multiply by: (100% less 30% tax rate) 70%
Interest expense net of tax 525,000
Diluted EPS = (2,400,000 + 525,000) ÷ (200,000 + 100,000)

Diluted EPS = 9.75
10. Solutions:
Basic EPS = 2,400,000 ÷ 400,000
Basic EPS = 6.00

Bonds payable (10,000 x P1,000) 10,000,000
Multiply by: Interest rate 10%
Total 1,000,000
246
Multiply by: Months outstanding 6/12
The weighted average number of outstanding ordinary shares for

diluted EPS computation is computed as follows:
January 1, 20x1 (400,000 x 12/12) 400,000
July 1, 20x1 (100,000 incremental shares x 6/12) 50,000
Total weighted average number of outstanding
ordinary shares 450,000
Diluted EPS = (2,400,000 + 350,000) ÷ (450,000)

Diluted EPS = 6.11
11. Solutions:
Basic EPS = 2,400,000 ÷ 400,000
Basic EPS = 6.00

The debt component of the convertible bond is computed as follows:
Present
Principal 2,000,000 0.711780 1,423,560
Interest 200,000 2.401831 480,366
feature 1,903,926

Bonds payable (Present value) 1,903,926
Multiply by: Effective interest rate 12%
Diluted EPS = (2,400,000 + 159,930) ÷ (400,000 + 100,000)

Diluted EPS = 5.12
12. Solutions:
Basic EPS = 2M ÷ 200,000
Basic EPS = 10.00
247
The treasury shares assumed to have been purchased under the
“treasury share method” is computed as follows:
Multiply by: Total exercise price* 300
Proceeds from assumed exercise of options 6,000,000
Assumed treasury shares purchased 15,000
*Total exercise price is computed as follows:

Exercise price 280
Fair value of each share option 20
Total exercise price 300
The incremental shares from the assumed exercise of the options are
Assumed treasury shares purchased ( 15,000)
Diluted EPS = 2M ÷ (200,000 + 5,000)
Basic EPS = 9.76
13. Solution:
Written put option shares 20,000
Multiply by: Repurchase price 100
Needed amount to satisfy the contract 2,000,000
Shares assumed issued to raise finance to
satisfy contract 25,000
The incremental shares from the assumed exercise of the options are
Shares assumed issued to raise finance to
satisfy contract 25,000
Written put option shares ( 20,000)
Incremental shares for diluted EPS computation 5,000
14. Solutions:
Basic EPS = P4M ÷ 100,000
Basic EPS = 40.00

The debt and equity components of the compound instrument are
determined as follows:
Proceeds received from issuance 2,200,000
248
(P2M x PV of P1 @10%, n=3) + (P240K x PV of an ordinary
annuity @10%, n=3) = (P2M x 0.751315) + (P240K x 2.486852) (2,099,474)
The after tax interest expense on the bonds is computed as follows:

Carrying amount of the bonds – January 1, 20x1 2,099,474
Multiply by: Effective interest rate 10%
Interest expense before tax 209,947
Multiply by: 1 minus tax rate 70%
Interest expense after tax 146,963
Diluted EPS = (P4M + 146,963) ÷ (100,000 + 100,000)

Diluted EPS = 20.73
15. Solutions:
Requirement (a): Basic loss per share
Loss for the period (2,400,000)
Preferred dividend (P1M x 6%) ( 60,000)
Total loss to ordinary shareholders (2,460,000)
Divide by: Ordinary shares outstanding 200,000
Basic loss per share ( 12.30)
Requirement (b): Diluted loss per share

Loss for the period (2,400,000)
Divide by: Ordinary shares outstanding + incremental
shares [200,000 + (50,000 x 2)] 300,000
Diluted loss per share ( 8.00)
Since the computed diluted loss per share decreased the loss per
share, only the basic loss per share shall be presented in the
financial statements.
16. Solutions:
Requirement (a): Basic loss per share
Basic earnings per share is computed as follows:
Basic EPS = (Profit or loss less Preferred dividends) ÷ Weighted Ave.
# of Outs. Ord. Sh.
Profit for the period 2,000,000
Divide by: Ordinary shares outstanding
[100,000 + (50,000 x 50%)] 125,000
Basic earnings per share 16.00
Requirement (b): Diluted loss per share

The incremental shares from the partly paid shares are computed as
follows:
Subscribed shares not fully paid up (50,000 x 50%) 25,000
249
Multiply by: Subscription price 300
Subscription proceeds assumed received 7,500,000
Assumed treasury shares purchased 18,750
The incremental shares from the partly paid shares are computed as
follows:
Subscribed shares not fully paid up 25,000
Assumed treasury shares purchased ( 18,750)
Incremental shares for diluted EPS computation 6,250

Profit for the period 2,000,000
Divide by: Ordinary shares outstanding plus
Incremental shares [100,000 + (50,000 x 50%)] + 6,250 131,250
Diluted earnings per share 15.23
250

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Financial Reporting

Theory and Practice

Nation’s Foremost CPA Review, Inc. (NCPAR)

If you have comments, queries or suggestions, please do not hesitate

Thanks and God bless.

Zeus Vernon B. Millan

CHAPTER 17 – CURRENT AND NONCURRENT LIABILITIES........1

Multiple choice – Computational (SET A)

2. B (1M x 80%) = 800,000 noncurrent; (1M – 800K) = 200,000

5. C (125,000 + 200,000 expiring in 20x4) + 140,000 expiring in 20x5 =

Two equal installments of real estate tax 12,000

Annual real estate tax 24,000

Accrued tax on warehouse - July and Aug. (2,000 x 2) 4,000

125,000 340,000 465,000

Remittance of sales tax in February (600)

Multiple choice – Computational (SET B)

4. A 4,000,000 - the refinancing agreement is not at the discretion

5. D None, the refinancing agreement is at the discretion of the

6. D None, the refinancing is completed as of the end of reporting

7. B - ₱200,000 representing the accrued interest on the loan (4M x

8. A - ₱4,000,000. The loan shall be presented as current despite

9. D None, the grace period was received by the end of reporting

10. A ₱4,000,000, the note is payable on demand. Only if an

Unearned income – Dec. 31, 20x1 (previous problem) 10,800,000

15. A 2,000,000 – the earned portion in 20x2.

16. B 1,200,000 – the earned portion in 20x3

17. A 2,000,000 – see table above

18. A (96,000,000 x 2/12) = 16,000,000

 Receipts from Jan. 1 to April 1 will receive the 2 semi-annual

The average monthly receipts are computed as follows:

The balance of unearned revenue as of December 31, 20x1 is

The beginning balance of unearned revenue is already earned during

23. A (400,000 x 0.385543) = 154,217

24. D (154,217 ‘see above’ x 110%) = 169,639

Answer to requirement (a): P5,400,000

Requirement (b): Advances are refundable

Unearned income – Dec. 31, 20x1 P5,400,000

Requirement (a): Current and noncurrent portions – December

Current portion of deferred revenue

Requirement (b): Service revenue – 20x2

Receipts from Nov. 1 to Dec. 31 (4M x 2) 8,000,000

Requirement (b): Subscriptions revenue – 20x1

b. Unearned revenue – gift certificates 160,00

Sales on accrual basis are computed as follows:

400,000 Net increase

Multiple choice – Computational (SET A)

3. B 418,250 – the cash price equivalent of the annuity purchased.

4. C (418,250 + 50,000 first payment made immediately) = 468,250

5. C (194,000 x 12.4% x 1/12) = 2,005

Multiple choice – Computational (SET B)

2. B (4,000,000 x 12% x 3/12) = 120,000

3. C (4,000,000 x 112% x 12%) = 537,600

4. B 4,000,000 – the cash price equivalent

Third trial: (at 7%)

In here, we need to perform interpolation. Looking at the values

To perform the interpolation, we will use the following formula:

Where: x% again is the effective interest rate.

Let us substitute the amounts of present values computed earlier on

The amount computed is added to 6% to derive the effective interest

Interest expense in 20x1 = 6.2695% x 4,000,000 = 250,780

6. A (4,000,000 x 106.2695%) = 4,250,780

7. A (4,000,000 x PV of 1 @12%, n=3) = 2,847,121

8. A 2,847,121 x 12% = 341,655