Under PAS/IAS 37, liabilities are divided into the

following:

TRADE AND OTHER PAYABLES

(Financial/Non-financial)

PROVISIONS

CONTINGENT LIABILITES
Obligations involving UNCERTAINTIES are either
provisions or contingent liabilities

A PROVISION is a liability whose existence as of

the reporting date is certain, but the amount or the
timing of the settlement is uncertain.

A CONTINGENT LIABILITY is a liability whose

existence as of the reporting date is uncertain or
when the amount of obligation cannot be reliably
estimated, even if it is probable to result in an
outflow of resources embodying economic benefits.
Probability means more likely than not to occur.
The probability that the event will occur is greater
than the probability that it will not (greater than
50%)

Distinction should be made among (Degree of

Expectations):
CERTAIN
PROBABLE
REASONABLE POSSIBLE/NOT
PROBABLE

REMOTE
The use of estimates is an
essential part of the preparation of
financial statements and does not
undermine their RELIABILITY
 Outflow of Determination of FS Presentation
Liability resources amount

Trade and other Probable Reliably Recognize at Face

payables measurable of Balance Sheet

Provisions Probable Reliably Recognize at Face

measurable with of Balance Sheet
estimation

Contingent Probable Not reliably Disclosures in the

liabilities measurable notes to FS

Reasonably Reliably Disclosures in the

possible measurable notes to FS
(not probable) or not

None Remote Reliably Ignore (neither

measurable recognize or
or not disclose)
 Case 1 – An airline is required by law
to overhaul its aircraft once every three
years.

IS THERE A LIABILITY?
Case 1 – Refurbishment Costs - Legislative Requirement
Present obligation as a result of a past obligating event -
There is no present obligation.
Conclusion - No provision is recognised.
The costs of overhauling aircraft are not recognised. Even a legal
requirement to overhaul does not make the costs of overhaul a
liability, because no obligation exists to overhaul the aircraft
independently of the entity's future actions-the entity could avoid
the future expenditure by its future actions, for example by
selling the aircraft. Instead of a provision being recognised, the
depreciation of the aircraft takes account of the future incidence of
maintenance costs, ie an amount equivalent to the expected
maintenance costs is depreciated over three years.
An airline is required by law to overhaul its aircraft once every three
years.
 Case 2 – The government introduces a
number of changes to the income tax system.
As a result of these changes, an entity in the
financial services sector will need to retrain a
large proportion of its administrative and sales
workforce in order to ensure continued
compliance with financial services regulation.
At the balance sheet date, no retraining of
staff has taken place.

IS THERE A LIABILITY?
Case 2 – Staff Retraining as a Result of
Changes in the Income Tax System
Present obligation as a result of a past
obligating event - There is no obligation
because no obligating event (retraining) has
taken place.
Conclusion - No provision is recognised
 Case 3 – An entity in the oil industry causes
contamination but cleans up only when required
to do so under the laws of the particular country
in which it operates. One country in which it
operates has had no legislation requiring cleaning
up, and the entity has been contaminating land in
that country for several years. At 31 December
2000 it is virtually certain that a draft law
requiring a clean-up of land already contaminated
will be enacted shortly after the year end.

IS THERE A LIABILITY?
Case 3 – Contaminated Land - Legislation
Virtually Certain to be Enacted
Present obligation as a result of a past obligating
event - The obligating event is the contamination of the
land because of the virtual certainty of legislation
requiring cleaning up.
An outflow of resources embodying economic
benefits in settlement - Probable.
Conclusion - A provision is recognised for the best
estimate of the costs of the clean-up.
 PROVISION FOR WARRANTIES

Warranty agreements require the seller to correct any deficiency in

quality, quantity or performance of the merchandise sold over a
specified period of time after the sale.

The expected cost related to revenues of the period shall be

recognized as expense in the same period in which the revenues
are recorded - MATCHING PRINCIPLE, even if the expenditures
is to be incurred at a subsequent period. Expected expenditures
give rise to a liability (provision) which should be reviewed
periodically to determine if the actual repairs approximates the
estimates
WARRANTIES THAT MERELY PROVIDE
ASSURANCE THAT THE PRODUCT WILL
FUNCTION AS INTENDED BASED ON
AGREED-UPON SPECIFICATIONS
 ILLUSTRATION (Warranty)
A Company sells appliances with a two-year warranty. Estimated
warranty costs for the first year is 3% of sales and for the second
year is 8% of sales. Sales and actual warranty cost are as follows:

2010 2011
Sales 2,500,000 4,750,000
Warranty costs 53,000 184,500

2010 2011
Cash 2,500,000 4,750,000
Sales 2,500,000 4,750,000

Warranty Expense 275,000 522,500

Provision for Warranty 275,000 522,500
(Sales x (3% + 8%))

Provision for Warranty 53,000 184,500

Cash 53,000 184,500
An analysis of the liability at the end of 2011 assuming that sales
and repairs occur evenly throughout the year is as follows:

2010 sales still under warranty:

(2,500,000 x ½) x 8% P100,000
2011 sales still under warranty:
(4,750,000 x ½) x 3% P 71,250
(4,750,000 x 8%) 380,000 451,250
Liability P551,250

Provision for Warranty 8,750

Warranty Expense 8,750

Provision for Warranty, Dec. 31, 2011

(275T-53T)+(522,500-184,500) P560,000
Less Estimated liability per analysis 551,250
Difference P 8,750
 EXERCISE (WARRANTY)

On Jan. 1, 2010 Adventure Company introduced a new line of products

that carries a three-year warranty against factory defects. Estimated
warranty costs related to peso sales are as follows: 1% of sales in the
year of sale, 2% of sales in the year after sale, and 3% of sales in the
second year after sale.
Sales and warranty expenditures for the period 2010 to 2012 were as
follows:
2010 2011 2012
Sales 1,000,000 2,500,000 3,500,000
Actual warranty
expenditures 8,000 38,000 112,500

Required: (a) Journal entries for 2010, 2011 and 2012 (b) Balance per
books of Provision for Warranty at the end of 2012 (c) Predicted
liability at the end of 2012
 EXERCISE (WARRANTY)
Packard Company started selling a new product that carried a two-year
warranty against defects. Based upon past experience with other
products, the estimated warranty costs related to peso sales are computed
as follows:
First year of warranty 3%
Second year of warranty 5%

Total sales and actual warranty repairs for 2009 and 2010 are given below:
2009 2010
Sales 4,200,000 6,960,000
Actual warranty expenditures 148,800 180,000

Required:
a. What amount should Packard report as its estimated warranty liability
as of December 31, 2010?
b. Based on the above data, assuming that sales and repairs occur evenly
throughout the year, how much would be the predicted warranty
expense covering 2009 and 2010 sales still under warranty as of 2010?
 WARRANTIES THAT PROVIDE SERVICE
OTHER THAN AGREED-UPON
SPECIFICATIONS, OR WHEN THE
CUSTOMERS ARE GIVEN THE OPTION TO
PURCHASE THE WARRANTIES
SEPARATELY
 ILLUSTRATION (Warranty)
A Company sells warranty contracts for appliances to cover a two-
year period. The appliance package sells for P28,000 including
warranty contract for P750. Estimated warranty costs for the first
year is 40% of sales and for the second year is 60% of sales.
Sales and actual warranty cost are as follows:

2010 2011
Sales (in package) 1,000 1,200
Warranty costs P80,000 P220,500

2010:

Cash/Accts. Rec. 28,000,000

Unearned Rev. on Warranty Contracts P750,000
Sales 27,250,000
 ILLUSTRATION (Warranty)

2010:

Cost of Warranty Contracts P80,000

Cash/Materials, etc. P80,000

Unearned Rev. on Warranty Contracts 150,000

Revenue from Warranty Contracts 150,000
(750,000 x 40%) x ½

2011:

Cash/Accts. Rec. 33,600,000

Unearned Rev. on Warranty Contracts P900,000
Sales 32,700,000
 ILLUSTRATION (Warranty)

2010:

Cost of Warranty Contracts P220,000

Cash/Materials, etc. P220,000

Unearned Rev. on Warranty Contracts 555,000

Revenue from Warranty Contracts 555,000

((750T x 40%) x ½) + ((750T x 60%) x 1/2 ) P375,000

(900,000 x 40%) x ½ 180,000
P555,000
 PROVISION FOR PREMIUMS

Entities offer gifts in the form of other goods that are distributed
to the customers upon redemption of proof of purchase. Such gift
in kind are called premiums. For premiums considered as a
component of the transaction price, the transaction price at
the date of sale is recorded partly as sales of goods sold to the
customer and partly as liability for performance obligation that will
be settled by the transfer of the promised premium.
 ILLUSTRATION

As part of A Company’s marketing program, every 10 product box

tops returned to the company the customer receive an attractive
prize that costs P8. The prize may be separately sold for P12
each. The company estimates that only 60% of the product box
tops reaching the customer will be redeemed.
Units Amount
Sales 2,000,000 P90,000,000
Prizes purchased 100,000 800,000
Prizes distributed 82,000
 Stand alone prices:
Main product P90,000,000
Premium
((2M x 60%)/10) x P12 1,440,000
P91,440,000

Cash/Accts. Rec. P90,000,000

Sales
(90M x 90M/91.44M) P88,582,677
Unearned Rev. on Premium
(90M x 1.44M/91.44M) 1,417,323

Upon redemption:

Unearned Rev. on Premium

(1,417,323 x 82T/120T) P968,504
Sales P968,504
 PREMIUMS REPORTED AS SELLING
EXPENSE

Prizes, gifts or other premiums may be offered to customers in

exchange for labels, coupons, box tops and wrappers to increase
sales. The cost of these premiums should be matched as
expenses against the revenues in the same period

Cost of expected claims of customers give rise to a liability

(provision).
 ILLUSTRATION

As part of A Company’s marketing program, every 10 product box

tops returned to the company the customer receive an attractive
prize. The company estimates that only 60% of the product box
tops reaching the customer will be redeemed.
Units Amount
Sales 2,000,000 P90,000,000
Prizes purchased 100,000 800,000
Prizes distributed 82,000
Cash 90,000,000
Sales 90,000,000

Premium inventory 800,000

Cash 800,000

Premium expense 656,000

Premium inventory 656,000
(82,000 x (800,000/100,000))

Premium expense 304,000

Provision on premium 304,000
((2M x 60%)/10 – 82,000 = 38,000 x P8)
 EXERCISE (PREMIUMS)

The Graphics Corporation embarked on a promotional program

whereby a “T” shirt costing P150 each is given away for every 100
bottle crowns returned plus P50. Graphics Corporation estimates that
only 40% of the bottle crowns in the hands of consumers will be
presented for redemption. The following information is available for
you:

Quantity Amount
Bottles sold 1,000,000 5,000,000
“T” shirts bought 1,500 225,000
“T” shirts distributed 1,000

Required: Journal entries

 EXERCISE (PREMIUMS)
Beginning the year 2010, the Alcatel Company began marketing a
new beer called “Serbesa”. To help promote the product, the
management of Alcatel is offering a special Serbesa beer mug to
each customer for every 20 specially marked bottles of Serbesa.
Alcatel estimates that out of the 300,000 bottles of Serbesa sold
during 2010 only 30% of the bottle caps will be redeemed. For the
year 2010, 5,000 mugs were ordered by the company at a total cost
of P140,000. A total of 4,000 mugs were already distributed to
customers.

Required:
a. What is the amount of the liability that Alcatel should report on
its December 31, 2010 statement of financial position?

b. How much is the premium expense reported on Alcatel’s profit

or loss for the year ended December 31, 2010?
 PROVISION FOR CUSTOMER AWARDS

Some companies grant their customers rewards for patronage of

their products and services. Customers are given points from their
purchases of goods and services from the entity. Such points
therefore, can be used by the customer as part or full payment for
goods and services offered by the entity or a third party.

For customer loyalty programs for which awards are supplied

by the entity, the consideration received or receivable for goods
sold is apportioned between the product or services sold and the
awards redeemable in the future (liability) based on relative fair
values. The liability is then recognized as revenue upon
redemption.
 ILLUSTRATION

A Company grants its customer 2 reward points for each P100

sales. Each point is redeemable in the form of merchandise and
equivalent to P1. The points accumulated may be used by the
customer as part payment for merchandise purchases in the
future. During the month of April 2010, total sales of the
company amounted to P24,000,000. Fair values of the
merchandise and the reward points are P23,520,000 and P480,000
respectively.
Allocation:
P24M x P23.52M/(P23.52M+480T) P23,520,000
P24M x P480T/(P23.52M+480T) 480,000
Total P24,000,000

Cash 24,000,000
Sales 23,520,000
Provision for Customer Awards 480,000

By the end of the first year, 40% of the points have been
redeemed and it is expected that only 90% of the points granted
will be redeemed by the customer.

Provision for Customer Awards 213,333

Sales 213,333
(480T/90%) x 40%
During the second year, the company redeemed additional 40%
and it is expected that only 95% of the points granted will be
redeemed by the customer.

Provision for Customer Awards 190,878

Sales 190,878

((480T/95%) x (40%+40%) ) = 404,211 – 213,333

On the third year additional redemptions were made bringing total

redemption to 100%.

Provision for Customer Awards 75,789

Sales 75,789

(480T – 213,333 – 190,878)

If awards are supplied by a third party, consideration
received is recognized as revenue in full. The accounting
procedures for premiums shall apply.

Cash 24,000,000
Sales 24,000,000

When points are redeemed, expense is recognized.

Customer Awards 213,333

Payable to third party 213,333

End of the year accrual expense is made.

Customer Awards 266,667

Provision for Customer Awards 266,667
(480,000 – 213,333)
 EXERCISE (Customer Rewards)
Ever Department Store grants loyalty awards to its customers. For every P500
purchase made by the customer, the customer receives a credit of 10 points
equivalent to P10. The accumulated points may be used by the customer as part
or full payment for merchandise purchased in the future.

During the year 2009, the company made sales aggregating P5,000,000 on which
100,000 points were awarded to customers of the P5,000,000, 2% is considered to
be allocable to the customer loyalty awards. During the same year, 25,000 points
were redeemed, and at December 31, 2009, it is expected that a total of 90,000
points would be redeemed relating to 2009 sales.

During 2010, an additional 35,000 points awarded in 2009 were redeemed and
Ever revised its estimates of total redemption for points granted in 2009 at 95,000
points.

Required:
a. Determine the amount of revenue recognized as a result of redemption of
reward points in years 2009 and 2010.
b. Determine the amount of liability to be presented on the statement of financial
position relating to customer loyalty awards at December 31, 2009 and
December 31, 2010
 DEPOSITS AND ADVANCES

Deposits and advances consist of cash or property

received but which are refundable to the depositor
or which have been collected or otherwise
accumulated to be remitted to third parties (such as
funds held for others).

Refundable deposits consist of cash or property

received from customers but which are refundable
after compliance with certain conditions (such as
refundable containers like bottles, drums, tanks and
barrels.
 ILLUSTRATION (Refundable Deposits)
A Company has the following information:

Bal. of deposits for returnable container Jan 1 P250,000

Deposits received during the year 800,000
Deposit refunded during the year 720,000
Deposit forfeited 60,000
Cost of containers from forfeited deposits 55,000
Accum. Depr. Of containers from forfeited deposits 15,000

Required: Journal entries

 Acquisition and depreciation of containers

Returnable containers xx,xxx

Cash xx,xxx

Expense xx,xxx
Accum. Depr. – Ret. Containers xx,xxx

When deposits are received

Cash 800,000
Deposits on Ret. Containers 800,000

Refunds of deposits

Deposits on Ret. Containers 720,000

Cash 720,000
Deposits forfeited

Deposits on Ret. Containers 60,000

Accum. Depr. – Ret. Containers 15,000
Returnable containers 55,000
Gain on forfeited deposit or unreturned
containers 20,000
 EXERCISE (Refundable Deposits)
Francesca Royale sells its product in returnable containers. The customers are
given a period of two years from the year of delivery to return the containers.
Containers not returned within the prescribed period are considered sold at the
amount of deposits forfeited. At Jan. 1, 2010, the balance of the account
Refundable Deposits on Returnable Containers is P250,000, consisting of the
following: For containers delivered to customers in
2008 P100,000
2009 150,000

During 2010, the company received additional deposits of P200,000 for containers
delivered to customers. Deposits refunded to customers during 2010 for return of
containers amounted to P267,000, as follows:
Deliveries in 2008 P82,000
Deliveries in 2009 110,000
Deliveries in 2010 75,000

Required:
Compute the balance of refundable deposits for returnable containers on
December 31, 2010.
 GIFT CERTIFICATES

Some retail store sell gift certificates to customers which

are redeemable in merchandise. Sale of gift certificates
creates a liability in the books.

Liability is settled either through redemption of

certificates in exchange for merchandise sold or through
expiration of gift certificates.

The Philippine Department of Trade and Industry ruled

that gift certificates no longer have an expiration date
 GIFT CERTIFICATES
However, GCs that are issued to customers "including, but
not limited to, those under loyalty, rewards, or
promotional programs" as determined by the DTI are not
covered by the new law
Coupons or vouchers that entitle the holder to "a discount
off a particular good or service," or "that may be
exchanged for a pre-identified good or service" are also
not included

Issuers and its accredited merchants may refuse to honor

a gift check if it is lost due to no fault of the issuer, or it is
mutilated or defaced not due to the issuer's fault and said
damage "prevents the issuer from identifying the security
and authenticity features thereof.“
Sale of gift certificates

Cash xx,xxx
Gift Certificate Outstanding xx,xxx

Redemption of gift certificates

Gift Certificate Outstanding xx,xxx

Sales xx,xxx

Expiration of gift certificates

Gift Certificate Outstanding xx,xxx

Revenue from forfeited gift certificates xx,xxx
 EXERCISE (Gift Certificates)

Smart corporation issues gift certificates in denominations of P200,

P300, and P500. These gift certificates are redeemable in merchandise
and expire one year after issue date. The company’s gross profit is an
average of 30%.

Based on past experiences, an average of ½ of 1% of total gift

certificates sold will not be redeemed by reason of expiration. The
company records revenue as certificates expire.

During 2010, the company sold P2,000,000 gift certificates through its
licensed distributors. At the end of the year, total redeemed gift
certificates had a sales value of P1,280,000.

Required: Journal entries.

 EXERCISE (Gift Certificates)

Robinson sells gift certificates redeemable only when merchandise

is purchased. The certificates have an expiration date of two years
after issuance. Upon redemption or expiration, Robinson recognizes
the unearned revenue as realized. Data for the year are as follows:

Unearned revenue, January 1 – P750,000; gift certificates sold –

P3,000,000; gift certificates redeemed – P2,750,000; expired gift
certificates – P150,000, cost of goods sold rate is 75%.

Required: Journal entries.

 LIABILITY FOR BONUSES
As incentives to officers, managers and even staff, many company
establish a bonus agreement, with the bonus usually based on
revenue or profit of the enterprise. This bonus is, in effect, part of
salaries or compensation expense and is reported as an operating
expense of the company. The amount of bonus if based on profit
can be computed as follows:

before deducting bonus and income tax

after deducting bonus but before deducting

income tax
before deducting bonus but after deducting
income tax

after deducting both bonus and income tax

 DIVIDENDS PAYABLE

Dividends payable is recorded and recognized

in the accounts upon DECLARATION OF THE
BOARD OF DIRECTORS.

Undeclared cash dividends on cumulative

preference shares (dividends in arrears) are not
recognized as liabilities because there is no
obligating event. Dividends in arrears on
cumulative preference shares are simply
disclosed in the notes to financial statements.
 TAXES AND EMPLOYEE-RELATED
LIABILITIES
Value-added Taxes

When sales are made

Cash (or receivable) XXXX

Sales XXXX
Output VAT XXXX

When purchases are made

Purchases/Assets/Expense XXXX
Input VAT XXXX
Cash (or payable) XXXX
Recognition of liability

Output VAT XXXX

Input VAT XXXX
VAT Payable XXXX

Settlement of liability

VAT Payable XXXX

Cash XXXX
Payroll Taxes

Payment of salaries

Salary expense XXXX

Cash XXXX
Withholding tax payable XXXX
SSS premium payable XXXX
Pag-ibig premium payable XXXX
PhilHealth premium payable XXXX

Employer’s contribution

Employees benefit expense XXXX

SSS premium payable XXXX
Pag-ibig premium payable XXXX
PhilHealth premium payable XXXX