PRACTICE SET LIABILITIES

Problem 1
The following information relates to Imus Company’s obligation as of December 31, 2006. For each of the
numbered items, determine the amount if any, that should be reported as current liability in Imus’s December
31, 2006 balance sheet.

Accounts Payable
Accounts payable per general ledger control amounted to P5,440,000 net of P240,000 debit balance in
supplier’s accounts. The unpaid voucher file included the following items that not had been recorded as of
December 31, 2006:

a.) A Company – P224,000 merchandise shipped on December 31, 2006 FOB destination, received January
10, 2007
b.) B Company – P192,000 merchandise shipped December 26, 2006 FOB shipping point, received January
16, 2007
c.) C Super Savings – P144,000 janitorial services for the three-month period ending January 31, 2007
d.) Meralco – P67,200 electric bill covering the period December 16, 2006 to January 15, 2007

On December 28, 2006 a supplier authorized Imus to return goods billed at P160,000 and shipped
On December 20, 2006 the goods were returned by Imus on December 28, 2006 but the P160,000 credit
memo was not received until January 6, 2007.

How much is the total accounts payable as of December 31, 2006?

a. 5,841,000 c. 5,712,000
b. 5,601,600 d. 5,923,200

Solution:
Beginning Balance 5,440,000
Net Debit Balance - add back 240,000
(supplier’s account normally have a credit balance. A
debit balance mean that the amount paid to them
already exceeded the amount that should have been
paid)
Item B (pag FOB Shipping Point, kung kelan shinip, 192,000
iyon ang date na irerecord)
(kapag FOB Destination, kung kelan na receive,saka
lang magrerecord)
Item C (144,000 x 2/3) 96,000
Item D (67,200 / ½) 33,600
Less: Late received credit memo (ibawas yung (160,000)
inassume na amount to be received kasi sinabi na
01/06/2007 officially binalik yung pera)
Total Accounts Payable 5,841,000

Payroll
Items related to Imus’s payroll as of December 31, 2006:

Accrued Salaries Wages 776,000

Payroll deduction for:
Income Taxes Withheld 56,000
SSS Contributions 64,000
Philhealth Contributions 16,000
Advances to Employees 80,000

What amount of payroll should be recorded as of December 31, 2006?

a. 832,000 c. 992,000
b. 912,000 d. 776,000
Solution:
Accrued Salaries Wages 776,000
Add: Income Taxes Withheld 56,000
SSS Contributions 64,000
Philhealth Contributions 16,000
Total Payroll 912,000

Note: ”Advances to Employees” ay short-term loan agreement between employer and employee, hence a
current asset.

Litigation
In May 2006, Imus became involved in a litigation. The suit being contested, but Imus’s lawyer believes there
is probable that Imus may be held liable for damages in the range between 2,000,000 and 3,000,000 and no
amount is a better estimate of potential liability than any other amount.

a. 2,500,000 c. 2,000,000
b. 3,000,000 d. 0

Solution:
Midpoint of the range (2,000,000 + 3,000,000 / 2) 2,500,000

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

Note Payable
A note payable to the BPI for 2,400,000 is outstanding as of December 31, 2006. The note is dated October 1,
2005, bears interest at 18% and is payable in three equal annual installments of 800,000. The first interest and
principal payment was made on October 1, 2006.

a. 800,000 c. 908,000
b. 872,000 d. 72,000

Solution:
Principal amount due 10/1/05 800,000
Add: Accrued Interest Payable (1,600,000 x 18% x 3/12) 72,000
Total 872,000

10/01/2005 first annual payment of 800,000 + 10/01/2006 second annual payment of 800,000 = 1,600,000
October – December 2006 = 3 months

Purchase Commitments
During 2006, Imus entered in a noncancellable commitment to purchase 320,000 units of inventory at a fixed
price of P5 per unit, delivery to be made at 2007. On December 31, 2006 the purchase price of this inventory
items had fallen to P4.40 per unit. The goods covered by the purchase contract were delivered in January 28,
2007.

a. 0.00 c. 1,600,000
b. 192,000 d. 1,408,000

Solution:
Estimated liability for purchase commitment [(5.00 per unit – 4.40 per unit) x 320,000 units] 192,000

Note: If an entity has a contract that is onerous, the present obligation under the contract shall be recognized
and measured as a provision. (PAS 37 par. 66)

An onerous contract is a contract in which the unavoidable costs of meeting the obligations under the contract
exceed the economic benefits expected to be received under it
Deferred Taxes
On December 31, 2006, Imus deferred income tax account has a 2006 ending credit balance of 772,800
consisting of the following items:

Causes by temporary differences in accounting Deferred Tax

For gross profit on installment sales 376,000 CR
For depreciation on property and equipment 576,000 CR
For product warranty expense 179,200 DR
772,800 CR

a. 772,800 c. 952,000
b. 0.00 d. 196,800

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

Product Warranty
Imus has a one-year product warranty on selected items on its product line. The estimated warranty liability
on sales made during 2005, which was outstanding as of December 31, 2005 amounted to 416,000. The
warranty costs on sales made in 2006 estimated at 1,504,000. Actual warranty costs incurred during the
current fiscal year 2006 are as follows:

Warranty claims honored on 2004 – 2005 sales 416,000

Warranty claims honored on 2005 – 2006 sales 992,000
Total warranty claims honored 1,408,000

a. 0 c. 512,000
b. 96,000 d. 1,504,000

Solution:
Outstanding warranty liability 416,000
Add: Warrant costs on sales 1,504,000
Less: Total warranty claims honored (1,408,000)
Total Product Warranty 512,000

Premiums
To increase sales, Imus inaugurated a promotional campaign on June 30, 2006. Imus placed a coupon
redeemable for a premium in each package of product sold. Each premium costs P100. A premium is offered
to customers who send in 5 coupons and a remittance of P30. The distribution cost per premium is P20. Imus
estimated that only 60% of the coupons will be recorded. For the six-month ended December 31, 2006, the
following is available:

Packages of product sold 160,000

Premium purchased 16,000
Coupons redeemed 64,000

a. 1,728,000 c. 576,000
b. 1,600,000 d. 1,152,000

Solution:
Estimated packages of products sold (160,000 x 60%) 96,000
Less: Coupons redeemed (64,000)
Outstanding balance 32,000
Quantity (32,000 / 5 coupons) 6,400
Total Premiums [(100 + 20 – 30) x 6,400) 576,000
Due to Five Six Finance Company
Imus accounting records show that as of December 31, 2006, 1,280,000 was due to Five Six Finance Company
for advances made against 1,600,000 of trade accounts receivable assigned to the finance company with
recourse.

a. 0 c. 1,280,000
b. 320,000 d. 1,600,000

Note: Kung magkano and initial na utang which is given, yon and irerecord. This transaction involves
assignment of accounts receivable, wherein the company obtained a loan using the receivable as security.
Accounts receivable – assigned will be included in trade and other receivables, while the related loan will be
reported under current liabilities.

Bonus Obligation
Imus Company’s president gets an annual bonus of 10% of net income after bonus and income tax. Assume
the tax rate of 30% and the correct income before bonus and tax is 9,600,000. (Ignore the effects of other
given items on net income)

a. 722,600 c. 396,000
b. 2,240,000 d. 628,000

Solution:
B= 10% (P9,600,000 – B – T)
T= 30% (P9,600,000 – B)
T= 2,880,000 - .30B
B= 10% [9,600,000 – B – (2,880,000 - .30B)]
B= 10% (9,600,000 – B – 2,880,000 + .30B)
B= 10% (6,720,000 - .70B)
B= 672,000 - .070B
1.07B 672,000
B= 672,000 / 1.07
Bonus 628,000 (rounded off)

Problem 2
You were able to obtain the following from the accountant for Agdangan Corp. related to the company’s
liabilities as of December 31, 2010.

Accounts Payable 650,000

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

The following additional information pertains to these liabilities.

a. All trade notes payable is due within six months from the end of the reporting period.
b. Bank notes-payable include two separate notes payable to Allied Bank.
(1) A P300,000, 8% note issued March 1, 2008, payable on demand. Interest is payable every six months.
(2) A 1-year, P500,000, 11 ½ % not issued January 2, 2010. On December 30, 2010, Agdangan negotiated a
written agreement with Allied Bank to replace the note with a 2-year, P500,000, 10% note to be issued
January 2,2011. The interest was paid on December 31, 2010.
c. The 10% mortgage note was issued October 1, 2007, with a term of 10 years. Terms of the note give the
holder the right to demand immediate payment if the company fails to make a monthly interest payment
within 10 days of the date the payment is due. As of December 31, 2016, Agdangan is three months behind in
paying its required interest payment.
d. The 12% mortgage note was issued May 1,2004, with a term of 20 years. The current principal amount due
is P1,500,000. Principal and interest payable annually on April 30. A payment of P220,000 is due April 30,
2011. The payment includes interest of P180,000.
e. The bonds payable is 10-year, 8% bonds, issued June 30, 2001. Interest is payable semi-annually every June
30 and December 31.

QUESTIONS:
Based on the above and the result of your audit, answer the following.
1. Interest payable as of December 31, 2010 is
a. 155,000 c. 143,000
b. 143,000 d. 215,000

Solution:
B1: 300,000 note payable to bank (300,000 x 8% x 4/12) March - June 8,000
C: Mortgage note payable – 10% (600,000 x 10% x 3/12) Oct - Dec 15,000
D: Mortgage note payable – 12% (1,500,000 x 12% x 8/12) May - Dec 120,000
Total Interest Payable, December 31, 2010 143,000

2. The portion of the Note Payable-bank to be reported under current liabilities as of December 31, 2010 is
a. 300,000 c. 800,000
b. 500,000 d. 0

Solution:
B1: Note payable to bank – payable on demand 300,000

Note: The 500,000 note payable to bank will be classified as noncurrent liability because it was refinanced as a
long-term basis as of December 31, 2010.

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

a. 3,950,000 c. 3,938,000
b. 4,138,000 d. 0

Solution:
Accounts Payable 650,000
Add: Note Payable – trade 190,000
Note Payable – bank (see no. 2) 300,000
Salaries and wages payable 15,000
Interest Payable (see no. 1) 143,000
Mortgage note payable – 10% (with breach of loan covenant) 600,000
Mortgage note payable – 12% (220,000 – 180,000) 40,000
Bonds Payable, due 7/1/11 2,000,000
Total Current Liabilities, 12/31/10 3,938,000

Note: In accordance with the revised PAS 1 par. 69, an entity shall classify a liability as current when:
(a) it expects to settle the liability in its normal operating cycle;
(b) it holds the liability primarily for the purpose of trading;
(c) the liability is due to be settled within twelve months after the reporting period; or
(d) the entity does not have an unconditional right to defer settlement of the liability for at least twelve
months after the reporting period.

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

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

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

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

a. 1,760,000 c. 3,960,000
b. 2,560,000 d. 1,960,000

Solution:
Note Payable – bank (see no. 2) 500,000
Add: Mortgage note payable – 12% (1,500,000 – 40,000) 1,460,000
Total Noncurrent Liabilities, 12/31/10 1,960,000

Problem 3
You are engaged to audit the December 31, 2014, financial statements of MILANI COMPANY; a manufacturer
of household appliances, your audit disclosed the following situations.
1. In June 2014, the company began producing and selling a new line of dishwasher. By the end of the year, it
had sold 120,000 to various dealers for 15,000 each. The product was sold under a 1 – year warranty, and the
company estimates warranty costs to be P750 per dishwasher. Milani had paid out P30 million in warrant
expenses as of December 31, 2014, which is also the amount shown as warranty expense in its income
statement for the year.
2. In response to your letter of audit inquiry. Milani’s lawyer informed you that the company is involved in a
lawsuit for violating environmental laws regulating hazardous waste. Although the litigation is pending,
Milani’s lawyer is certain that Milani will most probably have to pay cleanup costs and fines of P5,500,000.
Millani neither accrued nor disclosed this loss in the financial statements.
3. Milani is the defendant in a patent, infringement suit by Megan Yang over Milani’s use of a hydraulic
compressor in several of its manufactured appliances. Milani’s lawyer informed you that if the suit goes
against your audit client, the loss may be as much as P10 million. However, the lawyer believes that the loss of
this suit is only possible. Milani did not in any way disclose this pending litigation in its financial statements.

1. What amount of warranty expense should be shown on Millani’s income statement for the year ended
December 31, 2014?
a. 30,000,000 c. 0
b. 60,000,000 d. 90,000,000

Solution:
1: Warrant Expense (750 x 120,000) 90,000,000

2. What amount of warranty liability should be shown on Milani’s statement of financial position as of
December 31, 2014?
a. 60,000,000 c. 90,000,000
b. 30,000,000 d. 0

Solution:
Correct Warranty Expense 90,000,000
Less: Old Warrant (30,000,000)
Expense
Warrant Liability 60,000,000

3. What amount of lawsuit liability should be reported as a provision on Milani’s December 31, 2014,
statement of financial position?
a. 10,000,000 c. 5,500,000
b. 15,500,000 d. 0
Note: Yan ang probable amount sa item #2.

Problem 4
In conjunction with your firm’s examination of the financial statements of BATUR, Inc, as of December 31,
2014, you obtained the information from the company’s voucher register shown in the work paper below.

Ite Voucher
m Entry Date Referenc Description Amount Account Charged
No. e
Supplies shipped FOB destination
1 12/18/2014 12 - 200 15, 000 Supplies on hands
12/15/14; received 12/17/14
2 12/18/2014 12 - 203 Auto insurance, 12/15/14 - 12/15/15 22, 000 Prepaid Insurance
Repairs &
3 12/21/2014 12 - 209 Repairs services; received 12/20/14 19, 000
Maintenance
Merchandise, shipped FOB shipping
4 12/26/2014 12 - 212 123, 000 Inventory
point, 12/20/14; received 12/24/14
Payroll, 12/7/14 - 12/21/14 (12
5 12/21/2014 12 - 210 69, 000 Salaries and Wages
working days)
Subscription to industry magazine Dues & subscriptions
6 12/21/2014 12 - 234 5, 000
for 2015 expense
7 12/28/2014 12 - 236 Utilities for December 2014 24, 000 Utilities expense
Merchandise, shipped FOB
8 12/28/2014 12 - 241 destination, 12/24/14; received 111, 500 Inventory
1/2/15
Merchandise, shipped FOB
9 12/28/2014 12 - 242 destination, 12/24/14; received 84, 000 Inventory
1/2/15
Legal and Professional
10 1/2/2015 1-1- Legal services, received 12/28/14 46, 000
expense
Medical services for employees for
11 1/2/2015 1-2- 25, 000 Medical expense
December 2014
Merchandise, shipped FOB shipping
12 1/15/2015 1-3- 55, 000 Inventory
point, 12/29/14; received 1/4/15
Payroll, 12/21/14 - 1/5/15 (12
13 1/10/2015 1-4- working days in total, 4 working days 72, 000 Salaries and Wages
in January 2015)
Merchandise, shipped FOB shipping
14 1/10/2015 1-6- 64, 000 Inventory
point 1/2/15; received 1/6/15
Merchandise shipped FOB shipping
15 1/12/2015 1-8- 38, 000 Inventory
point 1/3/15; received 1/10/15
Maintenance Services received Repairs &
16 1/13/2015 1-9- 9, 000
1/9/15 Maintenance
Interest on Bank Loan 10/10/14 -
17 1/14/2015 1-10- 30, 000 Interest Expense
1/10/15
Machinery &
18 1/15/2015 1-11- Manufacturing, installed 12/29/14 254, 000
Equipment
19 1/15/2015 1-12- Dividend declared, 12/15/14 160, 000 Dividends Payable

Adjustments:
Nos. 1, 3, 4, 5, 7, 14, 15, 16, 17 & 19 (No Adjustments)

2.
Insurance Expense 917
Prepaid Insurance 917

6.
Prepaid Subscription 5,000
Dues and Subscription 5,000

8.
Accounts Payable 111,500
 Inventory 111,500

9.
Accounts Payable 84,000
Inventory 84,000

10.
Legal & Professional Fees Expense 46,000
Accounts Payable 46,000

11.
Medical Expenses 25,000
Accounts Payable 25,000

12.
Inventory 55,000
Accounts Payable 55,000

13.
Machinery 254,000
Accounts Payable - Others 254,000

PROBLEM 5
Ana Rosa, president of the APOPKA COMPANY, has a bonus arrangement with the company under which she
receives 10% of the net income (after deducting taxes and bonuses) each year. For the current year, the net
income before deducting either the provision for income taxes or the net income before deducting either the
provision for income taxes or the bonus is P4,650,000. The bonus is deductible for tax purposes, and the tax
rate is 30%.

1. Determine the amount of Ana Rosa’s bonus

Solution:
B= 10% (4,650,000 – B - T)
T= 30% (4,650,000 - B)
T= 10% [4,650,000 – B – (30% x 4,650,000 – B)]
B= 10% [4,650,000 – B – (1,395,000 - .30B)]
B= 10% (4,650,000) - B – (1,395,000 + .30B)
B= 465,000 - .1B - 139,000 - .70B
B= 325,000 - .70B
1.07B 325,000
B= 325,000 / 1.07
Bonus 304,206

2. Compute the appropriate provision for income tax for the year

Solution:
T = 30% (NI – B)
T= 30% (4,650,000 - 304,206)
Income Tax 1,303,738.2

3. Prepare the entry to record the bonus (which will be paid in the following year)

Bonus Expense 304,206

Bonus Payable 304,206

PROBLEM 6
Presented below are two independent situations. Answer the question at the end of each situation.

Situation 1
BARRADO CO., a machinery dealer, sells a machine for P22,200 under a 1 – year warranty contract that
requires the company to replace all defective parts and to provide the necessary repair labor at no cost to the
customers. With sales being made evenly throughout the year, Barrado sells for cash 600 machines in 2014
(half of the warranty expense is incurred in 2014, half in 2015). On the basis of past experience, the 1 – year
warrant cost are estimated to be P 510 parts and P 660 labor. Assume that in 2014, these warrant costs are
incurred exactly as estimated.

1. What amount of warrant expense would be charged against 2014 revenue?

a. 702,000 c. 153,000
b. 351,000 d. 396,000

Solution:
Warranty Expense 600 machines x warranty cost of 1,170 (P510 parts and P660 702,000
labor)

2. What amount of warranty liability would appear on the December 31, 2014 statement of financial position?
a. 0 (249,400) c. 702,000
b. 153,000 d. 351,000

Solution:
Warranty expense (see #1 solution) 702,000
Less: 2014 warranty expense (702,000 / (351,000)
2)
Warranty Liability – 2014 351,000

Situation 2
DP, INC. a dealer of household appliances sells washing machines at an average price of P8,100. The company
also offers to each customer to a separate 3 – year warrant contract for P810 that requires the company to
provide periodic maintenance services and to replace defective parts. During 2014, DP sold 300 washing
machines and 270 warranty contracts for cash. The company estimates that the warranty costs are P180 for
parts and P360 for labor.

Assume sales occurred on December 31, 2014. DP’s policy is to recognize income from the warranties on a
straight – line basis. IN 2015, DP incurred actual costs relative to 2014 warranty sales of P18,000 for parts and
P36,000 for labor.

1. What liability relative to these transactions would appear on the December 31, 2014, statement of financial
position and how would it be classified?
Current Noncurrent
A. 145,800 72,900
B. 72,900 72,900
C. 72,900 145,800
D. 0 215,700

Solution:
Total unearned revenue (810-unit price x 270 units sold) 218,700
Divided by: 3 years warrant contract 3
Current Liability, 12/31/2014 (218,700 x 1/3) 72,900
Multiply: remaining 2 years 2
Noncurrent Liability, 12/31/2014 (218,700 x 2/3) 145,800

2. What amount of warranty expense would be shown on the income statement for the year ended December
31, 2015?
a. 18,000 c. 36,000
b. 0 d. 54,000

Solution:
Total warranty liability [540-unit price (180 + 360) x 300 units sold] 162,000
Divided by: 3 years warrant contract 3
Warranty Expense, 12/31/2015 54,000
3. What liability relative to the 2014 warranties would appear on the December 31, 2015, statement of
financial position and how would it be classified?
Current Noncurrent
A. 145,800 72,900
B. 72,900 72,900
C. 72,900 145,800
D. 145,800 0

Solution:
Total unearned revenue (810-unit price x 270 units sold) 218,700
Divided by: 3 years warrant contract 3
Current Liability, 12/31/2015 72,900

Unearned revenue as of 01/01/2015 (218,700 – 72,900 expenses for 148,500

2014)
Less: Current Liability, 12/31/2015 (72,900)
Noncurrent Liability, 12/31/2015 72,900

PROBLEM 7
Burdeos Corporation, a listed company, is a manufacturer of confectionery and biscuits. Its end of reporting
period is December 31 Relevant extracts from its financial statements at 31 December 2009 are as follows:

Current liabilities
Provision
Provision for warranties 270,000
Non-current liabilities
Provision
Provision for warranties 180,000

Note 36 – Contingent liabilities

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

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

Estimated cost of repairs – products with minor defects 1,000,000

Estimated cost of repairs – products with major defects 6,000,000
Expected % of products sold during 2009 having no Defects in 2010 80%
Expected % of products sold during 2009 having Minor defects in 2010 15%
Expected % of products sold during 2009 having Major defects in 2010 5%
Expected timing of settlement of warranty payments
- Those with minor defects All in 2010
Expected timing of settlement of warranty payments 40% in 2010
- Those with major defects 60% in 2011

During the year ended December 31, 2010 the following occurred:
1. In relation to the warranty provision of P450,000 at December 31, 2009, P200,000 was paid out of the
provision. Of the amount paid, P150,000 was for products with minor defects and P50,000 was for products
with major defects, all of which related to amounts that had been expected to be paid in 2010.
2. In calculating its warranty provision for December 31, 2010, Burdeos made the following adjustments to the
assumptions used for the prior year:
Estimated cost of repairs – products with minor defects No change
Estimated cost of repairs – products with major defects 5,000,000
Expected % of products sold during 2010 having no defects in 2011 85%
Expected % of products sold during 2010 having Minor defects in 2011 13%
Expected % of products sold during 2010 having Major defects in 2011 2%
Expected timing of settlement of warranty payments
- Those with minor defects All in 2011
Expected timing of settlement of warranty payments 40% in 2011
- Those with major defects 60% in 2012
3. Burdeos determined that part of its plant and equipment needed an overhaul – the conveyer belt on one of
its machines would need to be replaced in about December 2011 at an estimated cost of P250,000. The
carrying amount of the conveyer belt at December 31, 2009 was P140,000. Its original cost was P200,000.

4. Burdeos was unsuccessful in its defense of the peanut allergy case and was ordered to pay P1,500,000 to
the plaintiffs. As at December 31, 2010 Burdeos had paid P800,000.

5. Burdeos commenced litigation against one of its advisers for negligent advice given on the original
installation of the conveyer’s belt referred to in (4) above. In October 2010 the court found in favor of
Burdeos. The hearing for damages had not been scheduled as at the date the financial statements for 2010
were authorized for issue. Burdeos estimated that it would receive about P425,000.

6. Burdeos signed an agreement with Craft Bank to the e Burdeos would guarantee a loan made by Craft Bank
to the subsidiary, Burgis Ltd. Burgis’ loan with Craft B P3,200,000 as at December 31, 2010. Burdeos was in
financial position at December 31, 2010.

QUESTIONS:
Based on the above and the result of your audit, answer the following
1. The warranty expense in 2010 is
a. 100,000 c. 400,000
b. 160,000 d. 230,000

Solution:
No defects in 2011 – 85% 0
Add: Products with minor defects (P1,000,000 x 13%) 130,000
Products with major defects (P5,000,000 x 2%) 100,000
Increase in provision in 2010 230,000
Less: Unused amounts reversed in 2010 (P270,000 – P200,000) (70,000)
Warranty Expense in 2010 160,000

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

2. The provision for warranties as of December 31, 2010 is

a. 580,000 c. 230,000
b. 480,000 d. 410,000

Solution:
Balance, 1/1/10 (270,000 + 180,000) 450,000
Less: Amounts used in 2010 (200,000)
Add: Increase in provision in 2010 (see no. 1) 230,000
Less: Unused amounts reversed in 2010 (70,000)
Balance, 12/31/10 410,000

Alternative Solution:
Increase in provision in 2010 230,000
Add: Balance of provision from 2009 payable in 2011 180,000
Balance, 12/31/10 410,000

A provision shall be used only for expenditures for which the provision was originally recognized. Provisions
shall be reviewed at the end of each reporting period and adjusted to reflect the current best estimate. If it is
no longer probable that an outflow of resources embodying economic benefits will be required to settle the
obligation, the provision shall be reversed.
3. The provision for warranties to be reported as current liabilities on December 31, 2010 is
a. 220,000 c. 150,000
b. 400,000 d. 330,000

Solution:
Balance of provision from 2009 payable in 2011 180,000
Add: Increase in provision in 2010:
Minor defects 130,000
Major defects (100,000 x 20%) 20,000
Provision for warranties – current 330,000

4. The provision for warranties to be reported as noncurrent as of December 21, 2010 is

a. 80,000 c. 260,000
b. 150,000 d. 330,000

Solution:
Provision for warranties, 12/31/10 (see no. 2) 410,000
Less: Current provision for warranties (see no. 3) (330,000)
Non-current provision for warranties 80,000

5. Total provisions to be reported in the statement of financial position as of December 31, 2010 is
a. 480,000 c. 410,000
b. 1,180,000 d. 1,360,000

Solution:
Provision for warranties, 12/31/10 (see no. 2 for solution) 410,000

The other items should be treated as follows:

Expected overhaul – not a provision; Burdeos has no present obligation to conduct over haul. Rather, it is
evidence that the conveyer belt’s useful life has been shortened.

Unpaid amount of P700,000 (re peanut allergy case) – not a provision; there is no uncertainty regarding
timing or amount of settlement. The amount should be included as part of trade and other payables.

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

Guarantee – not a provision; although the entity has a present obligation under the guarantee; it is not
probable that an outflow of economic benefits will be required to settle the obligation since Burdeos was in a
strong financial position at December 31, 2010. The guarantee would be disclosed as a contingent liability.