STRAIGHT PROBLEMS

PROVISIONS IN GENERAL

1. DISCUSSION EXERCISES

In relation to the estimated liability account of UST COMPANY, the following information were
presented to you for evaluation:

(a) On December 5, 2019, an employee filed a P3,000,000 lawsuit against UST COMPANY for
damages suffered when one of UST's equipment malfunctioned in August of 2019. UST's legal
counsel expects the company will lose the lawsuit and estimates the loss to be between
P500,000 and P1,500,000. The employee has offered to settle the lawsuit out of court for
P1,200,000 but UST will not agree to the settlement.

(b) UST recalled a product on August 1, 2019 due to recently proven health hazard. The products
recalled will be repaired free of charge. The company is uncertain whether all of the products
recalled will have a defect. The following estimate was made by the company's engineers and
accountants and approved by the board of directors:

Repair Cost Probability

500,000 25%

600,000 20%
800,000 35%
900,000 20%

(c) During December 2019, a competitor filed suit against UST for industrial espionage, claiming
P700,000 in damages. Management and legal counsel believe it is probable that damages will be
awarded to the plaintiff and the best estimate of the damages is P600,000.

(d) At the beginning of the year, UST guaranteed a P300,000 loan obtained by DLSU from BDO
UNIBANK. On December 31, DLSU defaulted from this loan and it is possible that UST will be
held liable to the bank for the loan of DLSU.

(e) In July 2019, ADMU brought action against UST for polluting the Pasig River with its waste
products. It is probable that ADMU will be successful but the amount of damages the entity
might have to pay should not exceed P1,500,000. The company's P3,000,000 comprehensive
public liability policy has a P200,000 deductible clause. UST estimates that the cash outflow is
equal to its net liability on the comprehensive public liability policy.

(f) The main production plant of UST COMPANY is located on the shores of a lake. The lake has
been rising for a number of years, and the company has installed dikes to prevent flooding. The
dikes are currently operating at or near capacity. Weather forecasters have predicted that the
lake will rise another 8 inches this coming summer (2020). If this occurs, significant damage will
likely result from stressing the dikes beyond capacity. UST COMPANY estimated a P4,000,000 to
P6,000,000 amount of loss should the flooding will not be prevented.

(g) UST is involved in litigation regarding a faulty product sold in a prior year. The entity has
consulted with an attorney and determined that it is possible that the entity may lose the case.
The attorney estimated that there is a 40% chance of losing. If this is the case, the attorney
estimated that the amount of any payment would be P1,000,000.

(h) During 2019, UST is the defendant in a breach of patent lawsuit. The lawyers believe there is an
60% chance that the court will not dismiss the case and the entity will incur outflow of benefits.
If the court rules in favour of the claimant, the lawyers believe that there is a 70% chance that
the entity will be required to pay damages of P800,000 and a 30% chance that the entity will be
required to pay damages of P600,000. Other amounts of damages are unlikely. The court is
expected to rule in late December 2020. There is no indication that the claimant will settle out
 of court. A 7% risk adjustment factor to the cash flows is considered appropriate to reflect the
uncertainties in the cash flow estimates. An appropriate discount rate is 10% per year.
REQUIREMENT: Based on the above information, how much is the total amount of provisions to
be reported on the statement of financial position as of December 31, 2019?

PREMIUMS LIABILITY

2. NU CORP. has initiated promotional program whereby each box of pancake mix contain one
coupon,. The customer is entitled for a frying pan if the customer submitted 3 coupons plus P30. NU
CORP. pays P50 for each frying pan and incurs additional P10 for handling and shipping costs upon
redemption. The following information are deemed relevant:

2019 2020
Number of boxes sold 150,000 180,000
Selling price per box P70 P75
Number of frying pans purchased 30,000 25,000
Inventory of frying pans at year-end 18,000 16,000

The company estimates that 40% of the coupons issued from boxes sold will be presented for
the premium redemption. Coupons are redeemable within one-year from the date of purchase
of the related pancake mix. REQUIREMENTS: (1) How much is the premiums expense to be
reported in 2019 and 2020? (2) How much is the estimated premiums liability to be reported at
the end of 2019 and 2020?

3. FEU CORP. issues coupons to consumers which may be presented on or before their expiration date
at retail food stores in order to obtain discounts on certain products produced by FEU. Retail food
stores are reimbursed equal to the face value of the coupons redeemed, plus 10% coupon face value
as compensation for handling costs. FEU honors request for coupon redemptions by retail food
stores received up to three months after the consumer expiration date, In FEU's experience, 60% of
the coupons issued ultimately are redeemed. Information with respect to the two series of coupons
issued by FEU during 2019 are as follows:

SERIES A SERIES B
Consumer expiration date June 30, 2019 December 31, 2019
Total face value of coupons issued P250,000 P500,000
Total payments to retailers as of 12/31/2019 148,500 275,800

REQUIREMENTS: (1) How much is the promotional expense to be reported in 2019? (2) How much is the
estimated liability for unredeemed coupons to be reported at the end of in 2019?

WARRANTIES LIABILITY

4. During 2019, UE CORP, introduced a new line of machines that carries a two-year warranty against
manufacturer's defects. Based on industry experience, the estimated warranty cost percentages
related to peso sales are as follows:
Year of sale 1%
Year after sale 6%
Sales and actual warranty expenditures for 2019 and 2020 were as follows:
Year Sales Actual Warranty Expenditures
2019 P1,000,000 1,400,000
2020 P54,000 89,000
REQUIREMENTS: (1) How much is the warranty expense to be recognized in 2019 and 2020,
respectively? (2) What is the estimated warranty liability as of December 31, 2019 and 2020,
respectively?

5. UP INC. owns a car dealership that it uses for servicing cars under warranty. In preparing its financial
statements, the eat entity needs to ascertain the provision for warranty that it would be required to
provide at the end of the year. Jon. The entity's experience with warranty claims is as follows: 60%
 of all cars sold in a year have zero defect, 25% of all 02 cars sold in a year have normal defect, and
15% of all cars sold in a year have significant defect.

The cost of rectifying a "normal defect" in a car is P10,000. The cost of rectifying a "significant
defect" in a car is P30,000. The entity sold 500 cars during the year.
REQUIREMENTS: What is the "expected value" of the warranty provision for the current year?

RESTRUCTURING PROVISION
6. On October 1, 2019 DLSU INC. decided to restructure the entity's operations as follows:
 DLSU has two factories located in Laguna and Batangas and it decided to shut down the
operations of its LAGUNA FACTORY
 Employees working in LAGUNA FACTORY would be retrenched on October 31, 2019, and would
be paid their accumulated entitlements plus six months' wages but also some of its workers
would be transferred to BATANGAS FACTORY which would continue operating.

On December 31, 2019, the following transactions and events had occurred:

 The retrenched employees have left and their accumulated entitlements have been paid.
However, an amount of P300,000, representing a portion of the six months' wages for the
retrenched employees, has still not been paid.
 Costs of P80,000 are expected to be incurred in transferring the remaining employees to their
new work in BATANGAS FACTORY. The transfer is planned for January 15, 2020.
 Unpaid marketing costs as of this date amounted to P100,000 to promote the new image of the
entity.
 One employee, MIKA REYES, remains in order to complete administrative tasks relating to the
closure of LAGUNA FACTORY and the transfer of employees to BATANGAS FACTORY. MIKA
REYES is expected to stay until January 31, 2020. Her salary for January will be P30,000 and her
retrenchment package will be P90,000, all of which will be paid on the day he leaves. MIKA
REYES would spend 70% of his time administering the closure of LAGUNA FACTORY, 20% on
administering the transfer of employees to BATANGAS FACTORY, and the remaining 10% on
general administration.
REQUIREMENT: What total amount should be recognized as restructuring provision on December
31, 2019?

DECOMMISSIONING PROVISION

7. On January 1, 2019, ADMU CORP. purchased on oil tanker depot at a cost of P2,000,000. The entity
is expected to operate the depot for 5 years after which it is legally required to dismantle the depot
and remove the underground storage tanks. The oil tanker depot is depreciated using straight line
with no residual value.

It is reliably estimated that the cost of decommissioning the depot will amount to P1,300,000. The
appropriate discount rate is 10%.

On January 1, 2022, the entity estimated that additional decommissioning cost is estimated at
P500,000.
On December 31, 2023, after 5 years of operating the depot, the entity paid a demolition entity to
dismantle the depot at a price of P2,000,000.
REQUIREMENTS: (1) How much is the estimated decommissioning liability at the end of 2019 and
2022 (2) How much is the gain or loss on settlement of decommissioning liability in 2023? (3) How
much is the net amount to be presented in profit or loss for 2019, 2022 and 2023?

MULTIPLE CHOICE (THEORIES)

1. Which of the following is correct regarding provisions?

A. The exact payee of estimated liabilities should be identified or determined in order for the
liability to exist.
B. Provision is a present obligation arising from a future event called as an obligating event.
 C. Uncertainty of the amount of the liability as well as the timing of its settlement
differentiates provisions from other types of liabilities.
D. None from the choices.
2. Which of the following creates a legal obligation?

A. Legislation or other operation of law.

B. Entity established pattern of past practice.
C. A contractual agreement between the entity and another party.
D. Both A and C

3. A provision shall be recognized when

A. There is a possible obligation arising from a past event, the outflow of resources is
probable, and an approximate, amount can be set aside toward the obligation.
B. There is a constructive obligation as a result of a past obligating event, the outflow of
resources is probable, and a reliable estimate can be made of the amount of the
obligation.
C. Management decides that it is essential that a provision be made for unforeseen
circumstances and keeping in mind this year the profits were enough but next year
there may be losses.
D. There is a legal obligation arising from a past obligating event, the probability of the
outflow of resources is more than remote but less than probable, and a reliable
estimate can be made of the amount of the obligation.

4. Regarding proper measurement of provisions, which of the following is incorrect?

A. Reimbursements just like gains from expected disposal of assets, are recognized only
when it is virtually certain. It is presented as a separate asset but gains from it can be
presented net of the losses on the financial statements.
B. The risks and uncertainties that inevitably surround many events and circumstances
shall be taken into account in reaching the best estimate of a provision.

C. If an entity has an onerous contract, the present obligation under the onerous contract
shall be recognized and measured as a provision. The amount to be recognized as
provision is the HIGHER amount between the cost of fulfilling the contract and the
compensation or penalty arising from failure to fulfil the contract.

D. Where the effect of the time value of money is MATERIAL, the amount of provision shall
be the present value of the expenditures expected to be required to settle the
obligation.

5. S1: When the provision involves a large population of items, the estimated liability shall be
measured as the midpoint of the possible outcomes.

S2: If an entity did not record an accrual for a present obligation and did not disclose the
nature of the obligation and the range of the loss, the loss is likely to be remote.

S3: If the provision is directly attributable to a certain asset, it is debited as cost of the asset.

A. True, false, false D. False, false, true

B. False, true, true E. True, false, true
C. True, true, false

6. Reporting is required for

A. All loss contingencies.

B. Loss contingencies that are possible and can be reliably measured.
C. Loss contingencies that are probable and can be reliably measured.
B. Gain contingencies that are probable and can be reliably measured.
7. An entity operates a plant in a foreign country. It is probable that the plant will be expropriated.
However, the foreign government has indicated that the entity will receive a definite amount of
compensation for the plant. The amount of compensation is less than the fair value but exceeds
the carrying amount of the plant. The contingent asset should be reported

A. In the statement of financial position

B. In the notes to the financial statements
C. As a fixed asset valuation allowance account
D. As a valuation allowance as part of shareholders' equity

8. Which of the following best describes the accrual approach of accounting for warranty cost?
A. Expensed when paid.
B. Expensed when incurred.
C. Expensed based on estimate in year of sale.
D. Expensed when warranty claims are certain.

9. The board of directors of an entity decided in the latter part of the current year to wind up
international operations in the Far East and move them to Australia. The decision was based on
a detailed formal plan of restructuring as required by PAS 37. This decision was conveyed to all
workers and management personnel at the headquarters in Europe. The cost of this
restructuring plan can be measured reliably. How should the entity treat this restructuring in the
financial statements for the current year-end?

A. Mention the decision to restructure and the cost involved in the chairman's statement
in the annual report since it is a decision of the board of directors.
B. Because the restructuring has not commenced before year-end, based on prudence,
wait until next year and do nothing in this year's financial statements.

C. Recognize a provision for restructuring since the board of directors has approved it and
it has been announced in the headquarters of the entity in Europe.

D. Disclose only the restructuring decision and the cost of restructuring because the entity
has not announced the restructuring to those affected by the decision and thus has not
raised an expectation that the entity would actually carry out the restructuring.

10. A provision should be recognized for which of the following?

A. Future operating losses

B. Possible losses from unfavourable outcome of court cases.
C. Decline in value of the asset due to impairment
D. Liability for unredeemed coupons

END OF HANDOUTS ---