the normal business practice,

CHAPTER 1 custom and a desire to maintain

LIABILITIES
Liabilities are present obligations of an
entity to transfer an economic resource
as a result of past events
Essential Characteristics of Liabilities:
1. The entity has a present
obligation.
2. The obligation is to transfer an
economic resource.
3. The liability arises from a past
event
PRESENT OBLIGATION
An obligation is a duty or responsibility
that an entity has no practical ability to
avoid. An obligation is always owed to
another party (or parties). The other party
(or parties) could be a person or another
entity, a group of people or other entities,
or society at large. It is not necessary to
know the identity of the party (or
parties) to whom the obligation is
owed.
Two types of Obligation
good business relations or act in
an equitable manner. (e,g.
Advances from related parties,
employees etc. retirement
benefits to be paid in excess of the
statutory requirements, bad debts,
provisions)
TRANSFER OF AN ECONOMIC
RESOURCES
How Likely?
To satisfy this criterion, the entity must
have a potential to be required to
transfer its own economic resource to
another party.
Potential – it does not need to be certain
or even likely for as long as the entity is
required to transfer economic resource –
which may or may not be caused by
future uncertain events, then the second
criteria is met already.
An economic resource is a right that
has the potential to produce economic
benefits.
Examples of transactions that give rise to
a transfer of an economic resources:

1. Legal Obligation – this are 1. Obligations to pay cash

obligations that are legally 2. Obligation to deliver goods or
enforceable as a consequence of services
binding contract or statutory 3. Obligations to exchange
obligation (e.g. Income Taxes, economic resources with another
Accounts payable for goods, party on unfavorable terms.
Notes payable, Lease liability, 4. Obligations to transfer an
Retirement Benefits obligations) economic resource if a specified
2. Constructive Obligation - is an uncertain future event occurs.
obligation to pay that arises out of (Conditional Obligations)
conduct and intent rather than a 5. Obligations to issue a financial
contract. Obligations arising out of instrument if that financial
AEC16 INTERMEDIATE ACCOUNTING 2 | SOUTHERN LUZON STATE UNIVERSITY
Vee Jay Myron P. Mestidio, CPA
 instrument will oblige the entity to Subsequent Measurement – Amortized
transfer an economic resource. Cost

PAST EVENTS For interest bearing instrument:

A present obligation exists as a result of Initial Measurement - Face Amount
past events only if:
Subsequent Measurement – Face
(a) the entity has already obtained Amount
economic benefits or taken an action;
and
CURRENT LIABILITIES
(b) as a consequence, the entity will or
Pas 1, par 69, provides that an entity
may have to transfer an economic
shall classify a liability as current when:
resource that it would not otherwise have
had to transfer. 1. The entity expects to settle the
liability within the entity’s
Obligating Event – creates a present
operating cycle
obligation because the entity has no
2. The entity holds the liability
realistic alternative but to settle the
primarily for the purpose of trading
obligations created by the event.
3. The liability is due within twelve
(Acquisition of goods is an obligating
months after reporting period.
event because it gives rise to an
4. The entity does not have an
obligation to pay a sum of money
unconditional right to defer
equivalent to the goods received)
settlement of the liability for at
least twelve months after the
reporting period.
MEASUREMENT OF
LIABILITIES NON-CURRENT LIABILITIES
Initial Measurement - Present Value The term non-current liabilities is a
residual definition. All Liabilities non
Subsequent Measurement – Amortized classified as current are recognized as
Cost non-current liabilities. Non-current
Liabilities include:
MEASUREMENT OF CURRENT
LIABILITIES 1. Noncurrent portion of long term
Initial Measurement - Face Amount debt
2. Finance Lease Liability
Subsequent Measurement – Face 3. Deferred Tax Liability
Amount 4. Long-term Obligation to Officers
5. Long-term deferred Revenue
MEASUREMENT OF NON-
CURRENT LIABILITY
For non-interest-bearing instrument:
Initial Measurement - Present Value
AEC16 INTERMEDIATE ACCOUNTING 2 | SOUTHERN LUZON STATE UNIVERSITY
Vee Jay Myron P. Mestidio, CPA
LONG-TERM DEBT FALLING Statement of Financial Position shall
DUE WITHIN ONE YEAR
include:
A liability which is to be settled within 1. Trade and Other Payables
twelve months after reporting period is 2. Current Provisions
classified as current liabilities, even if: 3. Short-term Borrowing
4. Current portion of long-term debt
a. The original term was for a period
5. Current Tax Liability
longer than twelve. (Current
portion of long term debt)
b. An agreement to refinance or to
reschedule payment on a long- ILLUSTRATIVE
term basis is completed after the TRANSACTIONS UNDER:
reporting period and before the Deferred Revenue
financial statement are authorized
for issue. Winarak Company sells medical
equipment service agreeing to service
BREACH FOR COVENANTS equipment for a 2-year period. The
If certain covenants relating to entity’s entity’s normal practice when cash
obligation were breached, the liability are receipts are received is to credit to
now payable on demand (Acceleration unearned service revenue and service
Clause). Classification of the liability contract cost are charged to service
even if payable for more than twelve contract expense.
months after reporting period is current Revenue from services is recognized as
liability. earned over the service period of the
Exception to general rule, is when the contract.
lender on or before the reporting period The following transaction occur in the first
agrees for a grace period for more than year:
twelve-month period after reporting
period, then such classification is still to Cash Receipts from service contract sold
be considered to noncurrent liability.
1,800,000.00
Exception to the Exception, lender after
Service contract costs
reporting period but before the financial
810,000.00
statements are authorized for use agrees
for a grace period for more than twelve Service contract revenue recognized
months after reporting period, then such 1,400,000.00
classification is to be considered as
Journal Entries:
current liability.
1. To record cash receipts from
PRESENTATION OF
services contracts sold:
CURRENT LIABILITIES
Under PAS 1, par 54, the minimum line Cash 1,800,000.00
items under current liabilities in the Unearned Srvc. Rev 1,800,000.00

AEC16 INTERMEDIATE ACCOUNTING 2 | SOUTHERN LUZON STATE UNIVERSITY

Vee Jay Myron P. Mestidio, CPA
 2. To record the service contract
cost:
Srvc. Contact Exp 810,000.00
Cash/ A/Payable 810,000.00
3. To record the service contract
revenue recognized:
Unearned Srvc. Rev 1,400,000.00
Srvc. Contract Rev 1,400,000.00
Remining Unearned Revenue (liability)
carry-forward for the next year
(Php 400,000.00)
Gift Certificates
Granular Megamall sells gift certificates
which are redeemable within their chain
of Department Store and Supermarkets
as well as other affiliated shops within
their megamall. This gift certificates can
be used to buy any of the merchandise
from the participating stores. During the
year, the following were noted as
transaction relating to gift certificates:
Gift certificates unredeemed at the start
of the year 400,000.00
Gift Certificates sold during the year
600,000.00
Gift Certificates redeemed during the
year 720,000.00
Gift Certificates expired during the year
80,000.00
Journal Entries:
1. When gift certificates are sold:
Cash 600,000.00
AEC16 INTERMEDIATE ACCOUNTING 2 | SOUTHERN LUZON STATE UNIVERSITY
Vee Jay Myron P. Mestidio, CPA
Gift Certificates Payable 600,000.00
2. When the gift certificates are
redeemed:
Gift Certificates Payable 720,000.00
Sales 720,000.00
3. When GC expired:
Gift Certificates Payable 80,000.00
Forfeited Gift Cert. 80,000.00
Remining Gift Certificate Payable
(liability) at the end of the year is: Php
200,000
(400,000+600,000-720,000-80,000)
Bonus Computation
Large Entities often compensate key
officers and employees by way bonus for
superior income realized during the year.
This is a way of showing appreciation of
the company towards a job well down for
the current operations of the company.
And also, to motivate its key officers and
employees towards the success of the
company.
Bonus Before Bonus and Tax
B = Income x Bonus Rate
Bonus After Bonus Before Tax
B = (Income – B) x Bonus Rate
Bonus After Bonus After Tax
B = (Income – B - T) x Bonus Rate
Bonus Before Bonus After Tax
B = (Income - T) x Bonus Rate
Refundable Deposit
A deposit of Php 10,000 is required from
the customer for returnable containers.
The containers cost Php 8,000.00.
Cash 10, 0000
Container’s deposit 10,000

Upon return of the container:

Container’s Deposit 10,000
Cash 10,000

Upon failure from the customer to return

the container
Container’s Deposit 10,000
Gain from Container’s Deposit 2,000
Sale from Container’s Deposit 8,000

AEC16 INTERMEDIATE ACCOUNTING 2 | SOUTHERN LUZON STATE UNIVERSITY

Vee Jay Myron P. Mestidio, CPA
CHAPTER 2 –
ACCOUNTING FOR 1. When Premiums are purchased
PREMIUM Premiums xxx
Cash xxx

PREMIUMS – are articles of value such

as toys, dishes, silverware and other
2. When the premiums are
goods given to a customer as a result of
distributed to customers.
past sales or sales promotion activities.
Premium Expense xxx
Premiums xxx
• Present Obligation
3. At the end of the year, if premiums
• Transfer Of Premiums In are still outstanding – estimated
Exchange Of The Sale Of premium liability is recognized.
Products And Services
• Past Events – Sale Of Premium Expense xxx
Merchandise Or Service As Estimated Premium Liability xxx
Obligating Event
NOTE ON THE
Accordingly, when the merchandise is FOLLOWING:
sold, an accounting liability exist Premium Expense
already for the future distribution of (Expected No. of premium to be
the premiums and the same shall be distributed during the year x Premium
given an accounting recognition. Expense per Unit)

Expected No. of premium to be distributed

during the year is computed by:
Initial Measurement -Face Amount (Number of Units Sold x Expectation (%) )
Subsequent Measurement - Face Amount / Coupons Required

Premium Expense per Unit is computed by:

(Costs of Premium + Other cost –
Current Liabilities Remittances)

Est. Premium Liability

(Beg, Premium + Premium Expenses -
Premiums Distributed / Redeemed)
*common error here is the beginning balance
since the usual approach for premiums are
treated as current liabilities they don’t
encompass recognition for more than one
period.

AEC16 INTERMEDIATE ACCOUNTING 2 | SOUTHERN LUZON STATE UNIVERSITY

Vee Jay Myron P. Mestidio, CPA
Premium Inventory (IAS 2 Inventories)
(Beg Inventory + Cost of Premiums
Purchased – Cost of Premium Distributed)
Cash Rebate or cash back uses
ILLUSTRATIVE EXAMPLE : cash register receipts, bar codes, rebate
coupons and other proof of purchase in
In an effort to increase sales, D’ in D’
order to refund money to their customers
Company inaugurated a sales
who buy merchandise from retailers
promotional campaign on June 30, 2020.
within a specified promo time.
The entity placed coupon redeemable for
a premium in each package of SB19 1. To recognize cash rebate program
merchandise sold.
Rebate Expense xx
Each premium cost P450 and five Est. Rebate Liability xx
coupons must be presented by a
customer to receive a premium. The 2. To record payments to customers
entity estimated that only 80% of the Est. Rebate Liability xx
coupon issued would be redeemed. Cash xx

For the six months ended December 31,

2021, the following information is
available.
Cash discount coupon is a
Packages of SB19 Merchandise sold 70,000 voucher or code (or some other form of
Premiums purchased 7,500 identification), which allows the customer
Coupons redeemed 30,000
to receive a discount on their purchase at
the time of their purchase.
JOURNAL ENTRIES 1. To recognize cash discount
1. When Premiums are purchased coupon offer
(7,500 x 450 = Php 3,375,000.00)
Cash discount coupon Exp xx
Premiums 3,375,000
Est. Coupon Liability xx
Cash 3,375,000

2. When the premiums are 2. To record payments to retailers

distributed to customers. Est. Coupon Liability xx
(30,000 /5 ) x 450 = Php Cash xx
2,700,000.00)
Premium Expense 2,700,000 The key difference between these two
Premiums 2,700,000
promotional marketing schemes is the
3. At the end of the year, if premiums time where the buyer can make use of
are still outstanding. [56,000 – their discount or rebate.
30,000) / 5] x 450 = 3,600,000 Cash Discount is usually can be used at
Premium Expense 2,340,000 the point of sale as an immediate
Est. Premium Liability 2,340,000

AEC16 INTERMEDIATE ACCOUNTING 2 | SOUTHERN LUZON STATE UNIVERSITY

Vee Jay Myron P. Mestidio, CPA
discount while rebate program can be
used after purchase.
Cash Discount - Jollibee/ Mcdo Discount
Coupons
Cash Rebate – Shopee/Lazada (Shopee
Coins)
Many entities uses a customer Loyalty
program to build brand loyalty, retain
their valuable customers and of course,
increase in sales volume.
This is generally designed to reward
customers for their purchases and to
provide incentives to make further
purchases.
A common examples of Customer
Loyalty programs are:
• Mabuhay Miles / Getgo
• SM Advantage Card
RECOGNITION:
Award Credits allocated consideration is
deferred revenue until such time the
credits is redeemed and shall now be
recorded as revenue.
Estimated Redemption rate
assessed each period.
Computation of revenue recognized in
any one period is computed on
“cumulative basis” to effect the
changes in estimates.
MEASUREMENT:
Award Credits are separately accounted
for as component of the initial sale.
(FV of the consideration received in
the initial sale will be allocated
AEC16 INTERMEDIATE ACCOUNTING 2 | SOUTHERN LUZON STATE UNIVERSITY
Vee Jay Myron P. Mestidio, CPA
between the award credits and the
sale based on the relative stand-alone
selling prices)
Sale = Award Credit + Stand-alone
selling price Value
Stand-alone selling price is the price at
which an entity would sell a promised
good or services separately to a
customer.
ILLUSTRATIVE EXAMPLE:
An entity, a grocery retailer, operates a
customer loyalty program. The entity
grants program members loyalty points
when they spend a specified amount on
groceries. Program members can
redeem the points for further groceries.
The points have no expiry date.
The sales during 2020 amounted to
P9,000,000 based on stand-alone selling
prices. During 2020, the customers
earned 10,000 points.
But management expects that 80% or
8,000 of these points will be redeemed.
The stand-alone selling price of each
loyalty point is estimated at P100.
On December 31, 2020, 4,000 points
have been redeemed in exchange for
is groceries.
In 2021, the management revised
expectations and now expects that 90%
or 9,000 points will be redeemed
altogether. During 2021, the entity
redeemed 4,100 points.
In 2022, further 900 points are
redeemed. Management continues to
expect that only 9,000 points will ever be
redeemed, meaning no more points will
be redeemed after 2022.
Allocation of Transaction Price
Product Sales 9,000,000
Point – Stand-alone SP
(10,000 * 100) 1,000,000
Total 10,000,000
Product Sales 8,100,000
(9,000,000 / 10,000,000 * 9,000,000)
Point 900,000
(1,000,000 / 10,000,000 * 9,000,000)
Total Transaction Price 9,000,000

Journal Entries - 2020

To record Initial sale
Cash 9,000,000
Sale 8,100,000
Unearned Revenue – Points 900,000

To record redemption of 4,000 points

Unearned Revenue – Points 450,000
Sales 450,000

Journal Entries - 2021

To record redemption of 4,100 points
Unearned Revenue – Points 360,000
Sales 360,000

Total points redeemed 8,100

(4,000 + 4,100)

Cumulative Revenue on Dec 31, 2021 810,000

(8,100 / 9000 * 900,000)
Revenue Recognized in 2020 (450,000)
Revenue to be recognized in 2021 360,000

Journal Entries - 2022

To record redemption of 900 points
Unearned Revenue – Points 90,000
Sales 90,000

Total points redeemed 9,000

(4,000 + 4,100+900)

Cumulative Revenue on Dec 31, 2022 900,000

(9,000 / 9000 * 900,000)
Revenue Recognized as of 2021 (810,000)
Revenue to be recognized in 2022 90,000

AEC16 INTERMEDIATE ACCOUNTING 2 | SOUTHERN LUZON STATE UNIVERSITY

Vee Jay Myron P. Mestidio, CPA
CHAPTER 3 – • Present Obligation as a result of
WARRANTY past events
• Probable that an outflow of
WARRANTY – a written guarantee, economic resources embodying
issued to the purchaser of an article by its economic benefits would be
manufacturer, promising to repair or required to settle the obligation
replace it if necessary, within a specified • The amount of the obligation can
period of time. be measured reliably.
Warranty usually attaches to home Past Events (Obligating Event) – sale
appliances like TV sets, stereo sets, of product which give rise to a
refrigerators and even for your cars etc. constructive obligation.
Probable outflow resources –
Elements of Accounting for Warranty likeliness to be the case or to happen

Warranty Expense - based on current Possible vs. Probable

year sales Must be recorded in the year Possible even in the slightest chance
of sale (matching Principles) you will start to record.
-based on past experience (sound Probable – you will only start
estimate based on past sales and recognizing a liability when an obligation
experience) is more likely to happen than not.
-denominated by Cost per unit sold or Reliable Estimate
percent of sales
Where no reliable estimate can be
Est. Warranty Liability made, no warranty liability is recognized.
Est. Liability beg.
+Warranty Exp Initial Measurement -Face Amount
-Actual Warranty Cost Incurred Subsequent Measurement - Face Amount
Est Liability end

Current Liabilities

2 ACCOUNTING FOR
WARRANTY LIABILITY
• Accrual approach
Soundest approach on accounting
Warranty Liability because it properly
matches cost with revenue.
AEC16 INTERMEDIATE ACCOUNTING 2 | SOUTHERN LUZON STATE UNIVERSITY
Vee Jay Myron P. Mestidio, CPA
In this approached we established an
estimated warranty liability over the
Accrual Approach
periods and assessed each period for its
reasonableness. Tokyo Heist Company sells washing
machine that carry a three-year warranty
• Expense as incurred approach
against manufacturer’s defect.
More convenient than accrual approach
Based on the entity’s experience,
since we don’t have to established an
warranty costs are estimated at P300 per
account for which to be assessed each
machine.
period.
During the current year, the entity sold
This approach is based on expediency
2,400 washing machines and paid
especially when the amount is not
warranty costs of P170,000.
substantial or the warranty period is
relatively short. At the end of reporting period of the
second year, another 120,000 warranty
cost were paid.
• Accrual approach
Current Year
When Estimated Warranty Cost is
When Estimated Warranty Cost is
recorded:
recorded: (300 * 2,400 = 720,000)
Warranty Expense xxx
Est. Warranty Liability xxx Warranty Expense 720,000
Est. Warranty Liability 720,000
When Actual Warranty Cost is
subsequently incurred and paid:
Est. Warranty Liability xxx When Actual Warranty Cost is
Cash xxx subsequently incurred and paid:
• Expense as incurred approach
Est. Warranty Liability 170,000
When warranty cost is actually incurred Cash 170,000
and paid: Year 2

Warranty Expense xxx When Actual Warranty Cost is

Cash xxx subsequently incurred and paid:
Est. Warranty Liability 120,000
Cash 120,000

AEC16 INTERMEDIATE ACCOUNTING 2 | SOUTHERN LUZON STATE UNIVERSITY

Vee Jay Myron P. Mestidio, CPA
Sale of Warranty
An entity sold a product for Php
3,000,000. The regular warranty period
for the product is for two years. The entity
sold an additional warranty of two years
at a cost of P 60,000.
The sale is recorded as:
Cash 3,060,000
Sales 3,000,000
Unearned Warranty Rev 60,000

If the cost are incurred evenly, the

unearned warranty revenue is amortized
at the end of the third year and fourth
year as follows:
Third Year
Unearned Warranty Revenue 30,000
Warranty Revenue 30,000

Fourth Year
Unearned Warranty Revenue 30,000
Warranty Revenue 30,000
(60,000 / 2 years)

AEC16 INTERMEDIATE ACCOUNTING 2 | SOUTHERN LUZON STATE UNIVERSITY

Vee Jay Myron P. Mestidio, CPA

CHAPTER 4 –
PROVISION
PROVISION - is an existing liability of
uncertain timing or uncertain amount.
The essence of a provision is that there
is uncertainty about the timing or amount
of the future expenditure.
It is this uncertainty that distinguishes
provision from other liabilities.
The liability definitely exists at the end of
reporting period, but the amount is
indefinite or the date when the obligation
is due is also indefinite, and in some
cases, the payee cannot be identified or
determined.
Provision may be the equivalent of an
estimated liability or a loss contingency
that is accrued because it is both
probable and measurable.
• Present Obligation, LEGAL OR
CONSTRUCTIVE, as a result of
past events.
• Probable that an outflow of
economic resources embodying
economic benefits would be
required to settle the obligation
• The amount of the obligation can
be measured reliably.
Past Events (Obligating Event) –
sale of product which give rise to a
constructive obligation.
Probable outflow resources –
likeliness to be the case or to happen
AEC16 INTERMEDIATE ACCOUNTING 2 | SOUTHERN LUZON STATE UNIVERSITY
Vee Jay Myron P. Mestidio, CPA
Possible vs. Probable
Possible even in the slightest chance you
will start to record.
Probable – you will only start recognizing
a liability when an obligation is more likely
to happen than not.
As a rule of thumb:
• Probable means the likeliness to
happen is more than 50%
• Possible means the likeliness to
happen is less than 50% or 50%
• Remote means 10% or less that
10% to occur.
Reliable Estimate
Where no reliable estimate can be made,
no liability is recognized.
Take note that when we use estimates
we don’t undermine the reliability or
accuracy, it is provided under PAS 37 par
25 provides that using estimates is an
essential part of preparation of Financial
Statement.
The standard suggests that by using a
range of possible outcomes, an entity
usually would be able to make an
estimate of the obligation that is
sufficiently reliable.
“Best Estimate”
The best estimate is the amount that an
entity would rationally pay to settle the
obligation at the end of reporting period or to
transfer it to a third party at the time.
Mnemonics on Measurement based on 20% sales (20%x1,000,000) 200,000
Best Estimate:
5% sales (5%x5,000,000)
1. Where a single obligation is being 250,000
measured, the individual most likely
Total expected value or cost of repairs
outcome adjusted for the effect of
450,000
other possible outcomes may be the
best estimate. E.g., Lawsuits
2. Where there is a continuous range of
possible outcomes and each point
in that range is as likely as any other, Current Liabilities
the midpoint of the range is used
Warranty Revenue – Sale made
evenly
3. Where the provision being
measured involves a large
1. Risk and Uncertainties
population of items, the obligation is
estimated by “weighting” all possible 2. Present Value of Obligation
outcomes by their associated
possibilities. The name for this 3. Future Events
statistical method of estimation is
“expected value” E.G Insurance 4. Changes in Provisions
company using actuarial reports 5. Use of Provision
Illustration – “expected value” method 6. Expected Disposal of Asset
An entity sells goods with a warranty under
7. Reimbursement
which customers are covered for the cost of
repairs of any manufacturing defects that 8. Future Events
become apparent within 6 months after
purchase. 9. Onerous Contract

If minor defects are detected in all products

sold, repair costs would be about
P1,000,000.
Risk and uncertainties

If major defects are detected in all products
sold, repair costs of P5,000,000 would result.
The entity’s past experience and future
expectations indicate that 75% of the goods
sold will have no defects, 20% will have
minor defects and 5% will have major
defects.
The expective value or cost of repairs is
measured as follows:
75% sales None -0-
AEC16 INTERMEDIATE ACCOUNTING 2 | SOUTHERN LUZON STATE UNIVERSITY
Vee Jay Myron P. Mestidio, CPA
The risks and uncertainties that inevitably
surround events and circumstances shall
be taken into account in reaching the
best estimate of a provision.
Risk describes variability of outcome.
A risk adjustment may increase the
amount at which a liability is measured.
As prudence dictates, caution is
needed in making judgment under
condition of uncertainty so that income
and assets are not overstated, or
expenses and liabilities are not
understated.
However, uncertainty does not justify the
creation of excessive provision or a
deliberate overstatement of liabilities.
In Prudence, (Conservatism) Do Not:
Overestimate Revenue
Underestimate Expenses
Understating Liabilities
Overstating Asset
Present Value of Obligation
One of the recognition criteria is that
provision should be measured reliably,
thus, Where the effect of the time value
of money is material, the amount of
provision shall be the present value of the
expenditure expected to settle the
obligation.
The discount rate should be a pretax rate
that reflects the current market
assessment of the time value of money
and the risk specific to the liability.
The discount rate should not reflect risk
for which cash flow estimates have
already been adjusted.
Future Events
Such future events include new
legislation and changes in technology.
Changes in provision
Provisions shall be reviewed at every end
of the reporting period and adjusted to
reflect the current best estimate.
AEC16 INTERMEDIATE ACCOUNTING 2 | SOUTHERN LUZON STATE UNIVERSITY
Vee Jay Myron P. Mestidio, CPA
The provision shall be reversed if it is no
longer probable that an outflow of
economic benefits would be required to
settle the obligation.
Where discounting is used, the carrying
amount of the provision increases each
period to reflect the passage of time.
Use of provision
A provision shall be used only for
expenditures for which the provision was
originally recognized.
This is a common problem in the practice,
for which stakeholder is always viewing
provision as a form of savings when the
expenses recognize does not
materialize. Stakeholder’s in their
consideration to make use of such
“savings” they were opting to apply such
in different expense items for which
violates fairness and reliability of
expenses.
Expected disposal of assets
Gains from expected disposal of assets
shall not be taken into account in
measuring a provision.
Instead, an entity shall recognize gain on
disposal at the time of the disposition of
the assets.
In other words, any cash inflows from
disposal are treated separately from the
measurement of the provision.
Reimbursements
Where some or all of the expenditure
required to settle a provision is expected
to be reimbursed by another party, the
reimbursements shall be recognized
when it is virtually certain that
reimbursement would be receive if the
entity settles the obligation.
The reimbursement shall be treated as a
separate asset and not netted against the
estimated liability for the provision.
The amount of reimbursement shall not
exceed the amount of the provision.
However, in the income statement, the
expense relating to the provision may be
presented net of the reimbursement.
Future operating losses
Provision shall not be recognized for
future operating losses.
In other words, a provision for operating
losses is not recognized because a past
event creating present obligation has not
occurred.
However, an expectation of future
operating losses is an indication that
certain assets may be impaired. An
impairment test for these assets may be
necessary.
Onerous Contract
If an entity has an onerous contract the
present obligation under the contract
shall be recognized and measured as a
provision.
An onerous contract is a contract in which
the unavoidable costs of meeting the
obligation under the contract exceed the
economic benefits expected to be
received under it.
PAS 37, paragraph 68, mandates that
the unavoidable costs under a contract
represent the “least net cost of exiting
from the contract”
AEC16 INTERMEDIATE ACCOUNTING 2 | SOUTHERN LUZON STATE UNIVERSITY
Vee Jay Myron P. Mestidio, CPA
The lower amount between the cost of
fulfilling the contract and the
compensation or penalty arising from
failure to fulfill the contract is the least
cost of exiting from the contract.
1. Warranties
2. Environmental Contamination
3. Decommissioning or
Abandonment Costs
4. Court Cases
5. Guarantee
a. Warranties-The best estimate of the
warranty cost is recognized as a
provision because there is clear
constructive obligation arising from an
obligating event which is the sale of the
product with warranty.
b. Environmental contamination-If an
entity has an environmental policy such
that other parties would expect the entity
to clean up any contamination, or if the
entity has broken current environmental
legislation, then a provision for
environmental damage shall be made.
The obligating event is the contamination
of the property which gives rise to
constructive or legal obligation. A
provision is recognized for the best
estimate of the cost of cleaning up the
contamination.
c. Decommissioning or abandonment
costs-When an oil entity initially
purchases an oil field, it is put under a
legal obligation to decommission the site
at the end of its life. The costs of
abandonment or decommissioning shall
be recognized as a provision and may be
capitalized as cost of the oil field.
d. Court case-After a wedding in the
current year, ten people died possibly as
a result of food poisoning from products
sold by entity. Legal proceedings are
started seeking damages from the entity.
e. Guarantee- In the current year, an
entity gives a guarantee of certain
borrowings of another entity. During the
year, the financial condition of the
borrower deteriorates and at year-end,
the borrower files a petition for
bankruptcy.
Accounting for RESTRUCTURING
PAS 37, paragraph 10, defines
restructuring as a “program that is
planned and controlled by management
and materially changes either the scope
of a business of an entity or the manner
in which that business is conducted”.
Events that may qualify
restructuring include:
1. Closure of business location in a
region or relocation business
activities from one location to
another or relocation of
headquarters from one country to
another.
2. Changes in management
structure, such as elimination of a
layer of management or making all
functional units autonomous.
3. Fundamental reorganization of an
entity that has a material and
significant impact on its
operations.
AEC16 INTERMEDIATE ACCOUNTING 2 | SOUTHERN LUZON STATE UNIVERSITY
Vee Jay Myron P. Mestidio, CPA
4. Sale or termination of a line
business
Provision for restructuring
Recognition of the provision for
restructuring is required because a
constructive obligation may arise from
the decision to restructure.
A constructive obligation for restructuring
arises when two conditions are present:
1.The entity has a detailed formal plan for
the restructuring which includes the
following:
a. The business being restructured.
b. The principal location affected.
c. The location, function and approximate
number of employees who will be
compensated for terminating their
employment.
d. Date when the plan will be
implemented.
e. The expenditures that will be
as
undertaken.
2. The entity has raised valid expectation
in the minds of the those affected that the
entity will carry out the restructuring by
starting to implement the plan and
announcing the main features to those
affected by it.
Amount of restructuring provision
A restructuring provision shall
include only direct expenditures arising
from the restructuring.
These expenditures are
necessarily incurred for the restructuring
and not associated with the ongoing
activities of the entity.
 For example, salaries and benefits
of employees to be incurred after
operations cease and that are associated
with the closure of the operation shall be
included in the amount of the
restructuring provision.
PAS 37, paragraph 81, specifically
excludes the following expenditures from
the restructuring provision:
a. Cost of retraining or relocating
continuing staff.
b. Marketing or advertising program
to promote the new company
image.
c. Investment in new system and
distribution network.
Such expenditures are
categorically disallowed as restructuring
provision because these are considered
to be expenses relating to the future
conduct of the business of the entity, and
thus are not liabilities relating to the
restructuring program.
A contingent liability is a possible
obligation that arises from past event and
whose existence will be confirmed only
by the occurrence or nonoccurrence of
one or more uncertain future events not
wholly within the control of the entity.
A contingent liability is a present
obligation that arises from past event but
is not recognized because it is not
probable that an outflow of resources
embodying economic benefits will be
required to settle the obligation or the
amount of the obligation cannot be
measured reliably.
AEC16 INTERMEDIATE ACCOUNTING 2 | SOUTHERN LUZON STATE UNIVERSITY
Vee Jay Myron P. Mestidio, CPA
Contingent liability and provision
The second definition states that a
contingent liability is a present obligation.
However, the present obligation is either
probable or measurable but not both
to be considered a contingent liability.
contingent liability but shall be
recognized as a provision.
Provision vs. Contingent Liability
Uncertain timing or uncertain amount
Uncertain timing and uncertain amount
Treatment of contingent liability
A contingent liability shall not be
recognized in the financial statements
but shall be disclosed only. The required
disclosures are:
a. Brief description of the nature of the
contingent liability.
b. An estimate of its financial effects.
c. An indication of the uncertainties that
exist.
d. Possibility of any reimbursement.
If a contingent liability is remote, no
disclosure is necessary.
Contingent asset
PAS 37, paragraph 10, provides the
following definitions:
A contingent asset is a possible asset
that arises from past event and whose
existence will be confirmed only be the
occurrence or nonoccurrence of one or
more uncertain future events not wholly
within the control of the entity.
A contingent asset shall not be Journal entries for 2020
recognized because this may result to
2020
recognition of income that may never be
Jan. 1
realized. Drilling platform 26,610,000
However, when the realization of income Cash 25,000,000
is virtually certain, the related asset is no Decommissioning liability 1,610,000
longer contingent asset and its
Dec. 31
recognition is appropriate.
Depreciation 2,661,000
A contingent asset is only disclosed Accumulated depreciation 2,661,000
when it is probable. The disclosure (26,610,000/ 10 years)
includes a brief description of the
contingent asset and an estimate of its Interest expense 193,200
Decommissioning liability 193,200
financial effects.
(12%x1,610,000)
If a contingent asset is only possible or
remote, no disclosure is required.
2021
Dec. 31
Illustrative Example –
Depreciation 2,661,000
Decommissioning Liability Accumulated depreciation 2,661,000
An entity extracts natural gas and
oil in the Philippine Deep. Interest expense 216,384
Decommissioning Liability 216,384
On January 1, 2020, the entity
constructed a drilling platform for P
Decom. Liab. – Jan. 1, 2020 1,610,000
25,000,000 and is required by Philippine Interest Expense 193,200
law to remove and dismantle the platform Carrying amount 1,803,200
at the end of its useful life of 10 years. Int. Exp. for 2021 216,384
(12% x 1,803,200)
The straight-line method is used in
depreciating the drilling platform. The
entity has estimated that such
decommissioning will cost P5,000,000.
Based on a 12% discount rate, the
present value of 1 for 10 years is 0.322.
Thus, the present value of the
decommissioning liability is P5,000,000
times 0.322 or P1,610,000.
The decommissioning liability is
initially recognized at present value and
include in the cost of the related asset.

AEC16 INTERMEDIATE ACCOUNTING 2 | SOUTHERN LUZON STATE UNIVERSITY

Vee Jay Myron P. Mestidio, CPA