PROGRAM: Bachelor of Science in Accountancy

LEVEL: 2
COURSE TITLE: INTERMEDIATE ACCOUNTING II
COURSE CODE: ATAE16
NO. OF UNITS: 6
PRE-REQUISITE: Intermediate Accounting I

MODULE TITLE: CURRENT LIABILITIES (continuation)

MODULE NO. : 1B

CONTENT:

UNEARNED INCOME
Unearned income represents advanced collection of income that is not yet earned. Prior to earning ,
unearned income is classified as liability.

Examples:
a. Advances received for future delivery of goods or rendering of services
b. Proceeds from sale of gift certificates redeemable in goods or services

Illustration 1: Unearned revenue-sale of goods

ABC Co. requires advance payments for custom-built guitar effects, gadgets and racks. The records of
ABC Co. show the following:

Unearned revenue, January 1, 20x1 1,000,000

Advances received during 20x1 10,000,000
Advances applied to orders shipped in 20x1 8,000,000
Advances pertaining to orders cancelled in 20x1 300,000

Requirements:
Compute for the current liability assuming:
a. The advance payments received are non-refundable
b. The advance payments received are refundable

Solutions:
Requirement a

Unearned revenue, January 1, 20x1 1,000,000

Advances received 10,000,000
Advances earned ( 8,000,000)
Orders cancelled ( 300,000)
Unearned revenue December 31, 20x1 2,700,000
 ==========

Requirement b

Unearned revenue, December 31, 20x1 2,700,000

Liability for refundable deposits (orders cancelled) 300,000
Total current liability for advances received 3,000,000
==========
The advances pertaining to the cancelled orders remain as liability, not as unearned income but as a
liability for refundable deposits.

Illustration 2: Deferred revenue-sale of services

ABC Co. sells service contracts that cover a 2-year period. The sales price of each contract is P1,000.
ABC sold 1,000 contracts evenly throughout 20x1. ABC’s past experience shows that of the total amount
spent for repair of service contracts, 40% is incurred evenly during the first contract year and 60% evenly
during the second contract year.

Requirements:
a. How much are the current and noncurrent portions of the deferred revenue to be presented in
ABC’s 20x1 statement of financial position?
b. How much is the service revenue recognized in 20x2?

Solution:
 Because the contracts are sold evenly, the total receipts of P1,000,000 (1,000 x P1,000) are
averaged.
 Revenue is earned over the 2 year period as follows:
1. The first half is assumed to have been sold on January 1, 20x1 and will be earned from January
1, 20x1 to December 31, 20x2.
2. The second half is assumed to have been sold on December 31, 20x1 and will be earned from
January 1, 20x2 to December 31, 20x3.

20x1 20x2 20x3 Total

Percentage earned -1st year 40% 60%
Percentage earned-2nd year 40% 60%
First half (1,000,000 /2) = 500,000 200,000 300,000
Second half (1,000,000/2) = 500,000 200,000 300,000
Earned portions 200,000 500,000 300,000 1,000,000

Requirement (a): Current and noncurrent portions-Dec. 31, 20x1

Current portion (earned portion in 20x2) 500,000

Noncurrent portion (earned portion in 20x3) 300,000
Total (1,000,000 – earned portion in 20x1 of 200,000) 800,000
========
Requirement (b): Service revenue – 20x2
Service revenue in 20x2 (300,000 + 200,000) 500,000
=======
Illustration 3: Unearned subscription-Monthly
ABC Co. sells monthly subscriptions for an industry publication. Subscriptions received after the
November 1 cut-off date are held for publication in the following year. Receipts during 20x1
subscriptions were made evenly. Information on subscriptions is shown below:
Unearned revenue-January 1, 20x1 3,000,000
Receipts from subscriptions during 20x1 24,000,000

Requirements:
a. How much is the unearned revenue balance on December 31, 20x1?
b. How much is the revenue from subscriptions during 20x1?

Solutions:
Requirement (a)
Subscriptions received after the Nov. 1 cutoff date will receive none of the monthly publications for the
year. Accordingly, these represent the unearned revenue balance as of December 31, 20x1:

Unearned revenue-December 31, 20x1 = 24,000,000 x 2/12 = 4,000,000

=========

Requirement (b): Subscriptions revenue – 20x1

Subscriptions revenue, 20x1 = 3,000,000 + (24,000,000 x 10/12) = 23,000,000
==========

OR

Unearned revenue, January 1, 20x1 3,000,000

Receipts 20x1 24,000,000
Unearned revenue, December 31, 20x1 ( 4,000,000)
Subscriptions revenue-20x1 23,000,000
==========

Gift Certificates
The accounting procedures for gift certificates are summarized below:
a. A contract liability is recognized when gift certificates are sold.
b. The contract liability is derecognized and revenue is recognized when the gift certificates are
redeemed (used).
c. As to gift certificates sold that are not exercised (referred to as “breakage”) PFRS provides the
following:
1. Proportionate method-if the entity expects that a portion of the gift certificates sold will not
be redeemed, the entity recognizes the expected breakage amount as revenue in the
proportion to the pattern of rights exercised by the customer.
2. Remote method-if the entity does not expect that a portion of the gift certificates sold will
not be redeemedx, the entity recognizes the expected breakage amount as revenue when
the likelihood of redemption becomes remote.
Illustration 4: Gift Certificates
An entity sells gift certificates as part of its sales promotion. During the year, the entity sells gift
certificates worth P100,000, of which P72,000 were redeemed.

Case 1: Proportionate method

Based on the entity’s past experience, 10% of gift certificates sold are never redeemed.

Requirement: Provide the journal entries:

Cash 100,000
Gift card liability 100,000
To record the sale of gift certificates

Gift card liability 72,000

Revenue 72,000
To record the redemption of gift certificates

Proportionate recognition of breakage revenue

Breakage revenue is recognized on a pro-rata basis in proportion to the value of actual redemptions.

Gift certificates sold 100,000

Multiply by: 10%

Total expected breakage 10,000

Gift certificates sold 100,000

Less: Total expected breakage ( 10,000)

Gift certificates sold net of expected breakage 90,000

Gift certificates redeemed 72,000

Divide by: Gift certificates sold net of breakage 90,000
Percentage of actual redemption 80%

Total expected breakage 10,000

Multiply by: Percentage of actual redemption 80%
_____________________________________________________________________________________
Amount of expected breakage recognized as revenue 8,000

Gift card liability 8,000

Revenue 8,000
To record revenue from expected breakage
Case 2: Remote Method

The entity expects that all the gift certificates sold will be redeemed.

Accounting:
The entity makes the first 2 entries above.
As to the breakage, the entity recognizes revenue only when the likelihood of redemption becomes
remote, for example, when the certificates were not redeemed after a long period of time.

Deposits for returnable containers

Illustration:
ABC Co. requires deposits from customers for the containers of goods sold. The customers are refunded
for the deposits received when the containers are returned within 2 years from the date of sale of the
related goods. Deposits for containers not returned within the time limit are regarded as proceeds from
retirement of the containers.
Information for 20x3 is as follows:
Deposits for containers on Dec. 31, 20x2 from deliveries in:
20x1 20,000
20x2 45,000 65,000
Deposits for containers delivered in 20x3 90,000
Deposits for containers returned in 20x3 from deliveries in:
20x1 9,000
20x2 25,000
20x3 46,000 80,000

Requirement: Compute for the liability for deposits on returnable containers as of December 31, 20x3.

Solution:

Liability for deposits

Ignored Deposits from 20x1
Returns from 20x1 Ignored 45,000 Deposits from 20x2
Returns from 20x2 25,000 90,000 Deposits from 20x3
Returns from 20x3 46,000
End 64,000

Security deposit from lease

Illustration:
On January 1, 20x1, ABC Co. received a P100,000 security deposit from a tenant in conjunction with a
10-year lease. ABC will return the security deposit to the tenant at the end of the lease term, net of
costs of any damages to the leased property. The discount rate is 10%.

Requirement: Provide the entries in 20x1.

Solution:
Jan 1, 20x1
Cash 100,000
Security deposit (100,000 x PV of 1 @10%, n=10) 0r (100,000 x 0.38554) 38,554
“Day 1” difference 61,446
December 31, 20x1
Interest expense (38,554 x 10%) 3,855
Security deposit 3,855

Deposits held under escrow agreement

Illustration:
ABC Co. maintains escrow accounts and pays insurance premiums for its customers. Escrow funds are
kept in interest bearing accounts. Interest, less a 10% service fee, is credited to the customer’s account
and used to reduce future escrow payments. Information on escrow accounts is shown below:
Escrow accounts liability, January 1, 20x1 200,000
Escrow payments received during 20x1 1,500,000
Insurance premiums paid during 20x1 500,000
Interest on escrow funds during 20x1 100,000

Solution:
Liability for escrow accounts
200,000 Jan 1, 20x1
1,500,000 Escrow payments received
Premiums paid 500,000 90,000 Interest net of 10% fee
December 31, 20x1 1,290,000

Accrued expenses
Accrued expenses are liabilities for expenses incurred but not yet paid.

Illustration:
ABC Co. is preparing its December 31, 20x1 year-end financial statements. The following information
was gathered:
 The bill for December’s utility costs of P30,000 was received and paid on January 10, 20x2.
 A P20,000 advertising bill was received on January 2, 20x2. Of the total billing, P15,000 pertain
to advertisements in December 20x1 and P5,000 pertain to advertisements in January 20x2.
 A lease, effective December 16, 20x0 calls for a fixed rent of P100,000 per month payable one
month after the commencement of the lease and every month thereafter. In addition, rent
equal to 5% of net sales over P1,000,000 per year is payable on January 31 of the following year.
 Total cash sales and collections on accounts amounted to P1,000,000. Accounts receivable has a
net increase of P200,000. Commissions of 15% of sales are paid on the same day cash is
received from customers.

Requirement: Compute for the accrued liabilities on Dec. 31, 20x1.

Solution:
Utility expense for December 20x1 30,000
Advertising cost incurred in December 20x1 15,000
Rent expense from December 16 to 31, 20x1 (100,000/2) 50,000
Contingent rent expense [(1,200,000 – 1,000,000) x 5%] 10,000
Additional commission expense 30,000*
Total accrued liabilities 135,000
=======

*Additional commission expense is computed as follows:

Total commission expense (1,200,000 x 15%) 180,000
Commission expense paid (1,000,000 x 15%) (150,000)
Additional commission expense 30,000
=========

Dividends payable
The liability to pay dividend is recognized when the dividend is appropriately authorized and is no longer
at the discretion of the entity, which is:
a. The date when the declaration of the dividend is approved by the relevant authority if such
approval is required
b. The date when the dividend is declared if further approval is not required
Dividends declared by banks are subject to the approval of the BSP.
Only cash and property dividends are recognized as liabilities. Stock dividends are not liabilities; share
dividends distributable (stock dividends payable) is presented in equity as an addition to share capital.

Liability for remittable collections

Liabilities may also arise from amounts collected on behalf of third parties. Examples:
a. Taxes withheld
b. SSS premiums, Philhealth, Pag-Ibig and similar contributions
c. Output value added taxes
d. Collections made by an agent or broker on behalf of a principal

REFERENCE: Millan, Zeus Vernon B. – Intermediate Accounting 2, 2021 Edition