Derivatives
Let’s Check
- August 25, 2020
Fill in the blanks: (ULO h) On the space provided for, write the correct answer
for every item described or defined below.
Futures Contract 1. It is traded in an exchange market, so the parties do not
know who is on the other side of the contract.
Profit or Loss 2. Under fair value hedge, loss or gain on interest rate swap is
reported immediately through __________ .
Interest Rate Swap 3. It is a contract where two parties agree to exchange cash
flows for future interest payments based on a contract of loan.
_True 4.
A derivative is a financial instrument that derives its value from the
movement in commodity price, foreign exchange rate and interest rate of an
underlying asset of financial instrument. (True or False)
Loss 5. Under fair value hedge, there is _______ on note payable when the fair value
of the note payable is higher than the carrying amount.
Forward Contract 6. It is designated as a cash flow hedge; an agreement to
purchase or sell a specified commodity on a future date at a specified price.
_Other comprehensive income 7.
reported through _______.
Unrealized gain on forward contract is
_Hedging 8. It is a means of protecting a financial loss such as interest rate swap,
forward contract, futures contract, option and foreign currency forward contract.
Unrealized Gain/loss – interest rate swap 9. This account is debited or credited
for decrease in the fair value of the swap receivable or payable due to passage of
time.
Cash Flow Hedge 10. The unrealized gain or unrealized loss is a component of
other comprehensive income because the derivative is designated as __________
type of a hedge..
_Purchases 11. On the date of the actual purchase, purchases is recorded equal
to the market price and the unrealized gain-forward contract is to be closed by
crediting/deducting it from this account.
_Option_premium 12. It is a right. Call option on the part of the buyer and put
option on the part of the seller. It is to be paid for and the amount paid is called
__________ .
1
True or false:(ULO h) Write true if the statement is true and false if the statement
is wrong.
False 1. A derivative instrument is best described as a contract that conveys to a
second entity a right to future collections on accounts receivable from a first entity.
False 2. All of the following are characteristics of a derivative:
a. It is required for the purpose of generating a profit from short term
fluctuation in market price.
b. The value changes in response to an underlying.
c. It requires no initial investment or an initial small investment.
d. It is settled at a future date.
True 3. One of the following is not a characteristic of a derivative financial
instrument;
a. The instrument has one or more underlying and an identified payment
provision.
b. The instrument requires a large investment at the inception of the contract.
c. The instrument requires or permits net settlement.
d. All of these are characteristics of a derivative financial instrument.
_True 4.Derivatives are measured at Fair value.
False 5. If the market price is greater than the strike or option price, the call option
is out of the money.
False 6. All of the following are based on a highly probable forecast transaction;
a. Forward contract
b. Futures contract
c. Option
d. Interest rate swap
True 7. The amount initially paid for a call option is Option premium.
False 8. Futures contract is unique in that it protects the owner against
unfavourable movement in the price while allowing the owner to benefit from
favourable movement.
_True 9. A derivative is a financial instrument that derives its value from the
movement in commodity price, foreign exchange rate and interest rate of an
underlying asset of financial instrument.
False 10. In a cash flow hedge, gain or loss on interest rate swap is recognized in
profit or loss.
2
Let’s Analyze –
Exercises. (ULO i) Getting acquainted with the essential terms in the study of
Derivatives is not enough, what also matters is your ability to analyze, solve and
journalize transactions of a problem situation. Now, I will require you to analyze,
solve and journalize the following transactions of these problems.
1. Exercise 1 On January 1, 20A Rode company received a 5-year variable interest
rate loan of 3,600,000 with interest payment at the end of each year and the
principal to be repaid on Dec. 31, 20E.
The interest rate for 20A is 8% and the rate in each succeeding year is equal to
market interest rate on January 1 of each year.
In connection with the loan, the entity entered into an interest rate swap
agreement with another financial institution.
The entity will receive a swap payment if the interest on January 1 is more than
8% and will make a swap payment if the interest is less than 8%.
The swap payments are made at the end of the year. This interest rate swap
agreement was designated as a cash flow hedge.
On January 1, 20B, the market rate of interest is 9% and on January 1, 20C, the
market rate of interest is 6%.
Present value of an ordinary annuity of 1 at 9% for 4 periods
3.24
Present value of 1 an ordinary annuity of 1 at 6% for 3 periods
2.67
Required: Prepare journal entries for 20A and 20B in connection with the loan
and the interest rate swap agreement. Show all of the necessary solution.
Answer:
Cash
3,600,000
Loans Payable
3,600,000
Interest expense
Cash
288,000
288,000
Interest rate swap receivable
Unrealized gain –IRS
Interest Expense
Cash
Cash
1% * 3,600,000*3.24
116640
116,640
324,000
324,000
36,000
Interest rate swap rec. 36,000
3
Unrealized gain – IRS
36,000
Interest expense 36,000
Unrealized Gain – IRS
80,640
Interest rate swap receivable
80,640
Unrealized loss – IRS
192,240
Interest rate swap payable
8-6=2%*3,600,000=72,000*2.67=
192,240
192,240
2. Exercise 2.On January 1, year 1Kyle Company borrowed 3,000,000 from Alpas
bank at a 8% fixed interest rate.
The interest is to be paid annually on December 31 of each year and the
principal to be repaid on December 31, year 3. The loan is evidenced by a
signed promissory note.
On January 1, year 1, the entity entered into a “receive fixed, pay variable”
interest rate swap with a speculator and has designated the swap as a fair value
hedge of the fixed interest rate loan.
The market rate of interest on January 1 of each year determines the interest
swap settlement to be made every December 31.
Market rates of
January 1, year
January 1, year
January 1, year
interest:
1
2
3
8%
10%
11%
The present value of 1 at 10% for two periods is .8264; the present value of an
ordinary annuity of 1 at 10% for two periods is 1.7355 and the present value of
1 at 11% for one period is 0.9009.
Answer:
January 1, year 1
December 31
Cash 3,000,000
Notes Payable
3,000,000
Interest expense (3,000,000*8%)
Cash
Dec. 31
PV of principal (3,000,000*.8264) 2,479,200
PV of fixed interest (240,000 *1.7355)
416,520
4
240,000
240,000
Total FV
Carrying Amount
Decrease in liability – gain
2,895,720
3,000,000
104,280
Note payable
104,280
Gain on note payable
104,280
Loss on interest rate swap
104,130
Interest rate swap payable
3,000,000*.02
60,000
* 1.7355 =
104,130
December 31 year 2
104,130
Interest expense 2,895,720*.10
Interest paid
3,000,000*. 08=
Amortization of discount on N/P
=
289,572
240,000
49,572
Interest Expense 289,572
Cash
240,000
Note payable
49,572
Another entry to recognizegain or lsos on N/P
PV of principal
3,000,000 * .9009
=
2,702,700
PV of interest
240,000 *.9009 =
216,216
Total
2,918,916
Carrying amount of N/P 2,895,720 + 49,572=
2,945,292
Decrease in note payable - gain
26,376
Note payable 26,376
Gain on note payable
26,376
Interest rate swap payable 2%*3,000,000 60,000
Cash
60,000
To record swap payment to speculator
Net cash to be paid to speculator
11%-8% = 3%
*
90,000
� PV of 1 at 11% for one period
.9009
� Interest rate swap payable end
81,081
Interest rate swap payable balance 104,130-60,000=
44,130
5
3,000,000=
Increase in Interest rate swap payable
36,951
Loss on interest rate swap 36,951
Interest rate swap payable 36,951
Year 3
Interest expense FV of N/P
Interest paid
240,000
Amortization of discount
81,081
Interest expense
Cash
Note payable
Dec. 31
90,000
2,918,916 * .11 =
321,081
321,081
240,000
81, 081
Interest rate swap payable
3,000,000 * .03
Cash
90,000
To record payment to speculator.
Final cash payment to speculator
90,000
CA of Interest rate swap payable 81,081-90,000
Loss on interest rate swap
81,081
8,919
Loss on interest rate swap 81,081
Interest rate swap payable 81,081
Note payable
Cash
3,000,000
3,000,000
3. Exercise 3 On Sept. 1, 20A, Celine Company determined that it will need to
purchase 80,000 kilos of tuna fish on January 31, 20B. Because of the volatile
fluctuation in the price of tuna fish, on Sept. 1, 20A, the entity negotiated a
forward contract with a reputable financial institution for the entity to purchase
80,000 kilos of tuna fish on January 31, 20B at a price of 6,400,000 or 80 per
kilo. The forward contract is designated as a cash flow hedge.
The market price of tuna fist per kilo is 78 on December 31, 20A and 75 on
January 31 20B.
Required: Prepare journal entries for 20A and 20B.
Answer:
6
December 31, 2017 80-78=2(80,000)=160,000
Unrealized Loss – FC160,000
Forward Contract payable
160,000
January 31, 20B
78-75=3 * 80,000
=
240,000
Unrealized loss – FC
240,000
Forward contract payable
240,000
Forward Contract payable 400,000
Cash
400,000
Purchases
(80,000 * 75)
6,000,000
Cash
6,000,000
Purchases
400,000
Unrealized Loss - FC
4. Exercise 4 Gen Company requires 45,000 kilos of soya beans each month in
the manufacture of its product. To eliminate the price risk associated with the
purchase of soya beans on Dec. 1, 20A, the entity entered into a futures
contract as a cash flow hedge to buy 45,000 kilos of soya beans at 150 per kilo
on Feb. 1, 20B.
Required: Prepare journal entries for 20A and 20B assuming:
a. The market price per kilo of soya beans is 160 on Dec. 31, 20A and 165 on
Feb 1, 20B.
b. The market price per kilo of soya beans is 160 on Dec. 31, 20A and on Feb 1,
20B is 145.
Answer: Case a
160-150=10*45,000
=
450,000
Futures Contract receivable 450,000
Unrealized Gain – FC
450,000
Feb. 1, 20B
165-160
=
5
*
45,000
=
Futures contract receivable 225,000
Unrealized gain – FC
225,000
Cah
675,000
Futures contract rec. 675,000
Unrealized gain – FC
Purchase
675,000
675,000
Purchases 165*45,000=
7,425,000
7
225,000
Cash
7425,000
Case B
Dec. 31, 20A
160-150=10*45,000
=
450,000
Futures Contract receivable 450,000
Unrealized Gain – FC
450,000
Feb 1, 20B
160-145
=
15
Unrealized Gain – FC
Unrealized loss – FC
FC receivable
FC payable
*
45,000
=
450,000
225,000
450,000
225,000
Purchases 145*45000 =
Cash
Purchases 225,000
UL- Fc
675,000
6,525,000
6,525,000
225,000
5. Exercise 5 Rizza company uses approximately 140,000 units of raw material in
the manufacturing operations. On Dec. 1, 20A, the entity purchased a call
option to buy 140,000 units of raw material on June 1, 20B at a price of 25 per
unit.
The entity paid 14,000 for the call option and designated the call option as a
cash flow hedge against price fluctuation for the June purchase.
On December 31, 20A, the market price of the raw material is 27 per unit and on
June 1, 20B the market price is 28.
Required: Prepare journal entries for 20A and 20B to record the call option and
the purchase of the raw material.
Answer:
Option
14,000
Cash
14,000
27-25
=
2
*
140,000
=
8
280,000 – 14,000=266,000
Call Option
266,000
UG- Option 266,000
28-25=3 * 140,000
=
420,000-280,000=140,000
Call option
140,000
UG – option 140,000
Cash
420,000
Call option
420,000
Purchases
28*140,000 =
Cash
3,920,000
3,920,000
UG – option
406,000
Purchases 406,000
In a Nutshell
In not less than 50 words, explain the importance of entering into derivative
contracts from a business owner’s viewpoint. Please answer in English only.
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9
Let’s Check
Activity 1. (ULO e) Now that you know the most essential terms in the study of
fund and other investments, let us try to check your understanding of these terms
and how it is accounted for. In the space provided, write the letter of your choice.
Identification: On the space provided for, write the correct answer to the
questions below.
1. Cash Surrender Value It is the amount which the insurance firm will pay upon
the surrender and cancelation of the life insurance policy.
2. __Fund____ This term refers to cash and other assets set aside for specific
purpose which can be current or non-current purpose.
3. Life insurance policy Is in connection with a company insuring its officers and
names itself as beneficiary to compensate for the loss of service from an
untimely death.
4. Retained Earnings account The recognition of cash surrender value on the
third year involves charging or crediting the life insurance expense to amount
concerning the current year, while the amount concerning to prior years is
charged through this account.
5. Prepaid insurance The payment of insurance premiums involves a debit to life
insurance expense and a credit to cash. When at the end of the year, a portion
of the payment has not yet expired, this is the account to be debited for an
adjusting entry.
6. Bond Sinking Fund It is oftentimes called redemption fund, the purpose of
which is for liquidating long term debts.
7. Funder under the administration of the entity This fund requires
distinction whether the fund is in the form of cash, securities and other assets
8. Insurance Expense If the beneficiary is the officer insured or anyone but not
the company, the entry for the payment of the premium is simply to credit cash
and a debit to this account.
9. Gain on life insurance settlement Upon receipt of the cash surrender value
due to the death of the company president, this is the amount credited for the
difference between the face of Policy and the cash surrender value and
unexpired premium.
10.Preference Share redemption fund This type of fund is set up for the
redemption of the preference share.
True or False: On the space provided for, write the true if the statement is correct
and false if the statement is wrong.
______1. Interest in life insurance contract shall be carried at Cash surrender value.
False__2. An increase in the cash surrender value is recorded by increasing annual
insurance expense.
10
False 3. Upon the
death of an officer,
an entity received
the proceeds of a life policy held by the entity on the officer. The amount of
revenue should be reported at proceeds received less cash surrender value.
False_4. If a sinking fund is used to purchase securities, the fund is not affected by
revenue earned on the securities. The fund is affected upon receipt of
interest on the securities and sale of the securities
True_5. A trustee holds cash in the sinking fund representing annual deposits to
the fund and interest earned. The sinking fund should be classified as noncurrent
assets.
False_6. When the sinking fund contribution is a one - time contribution, the fund
to be accumulated is divided by present value factor of 1 at a certain percent for
that number of years. Future Value is used.
Contingency fund 7. A fund that is set aside for meeting obligations arising from
contingencies such as an unfavourable outcome of a lawsuit is called Contingency
Fund.
Let’s Analyze
Activity 1. Getting acquainted with the essential terms in the study of accounting
for fund and other investments, what also matters is you should be able to solve
and journalize transactions on a problem situation. Now, I will require you to
prepare journal entries on the following problems and also answer questions being
asked.
Exercise 1. (ULO f) (Adapted Valix 2017 981)
On January 1, 2017, Hannah company established a sinking fund for the retirement
of a bond issue.
2017
Jan. 1, 2017 Established a sinking fund with 3,510,000 cash.
18
Purchased equity securities for 3,250,000.
July 5
Paid fund expenses of 130,000.
Sept. 9
Sold equity securities having an original cost of 780,000 for
689,000.
Dec. 20
Received dividends of 195,000 on equity securities.
2018
Feb. 12
Invested 500,000 in money market instruments.
Dec. 31
Received interest and dividends for 270,000.
Dec. 31
Sold all securities in the fund for 2,250,000 and retired an outstanding
bond issue of 3,000,000.
The remaining fund balance was transferred back to the general cash account.
Required: Prepare journal entries to record the transactions for 2017 and 2018.
ANSWER:
11
Jan. 1, 2017 Sinking
Fund Cash
3,510,000
Jan. 18, 2017
Cash
3,510,000
Sinking Fund Securities
Sinking Fund Cash
3,250,000
3,250,000
July 5, 2017 Sinking fund expense
130,000
Sinking fund Cash
130,000
Sept. 9, 2017
Sinking Fund Cash
689,000
Loss on sale of SF securities 91,000
Sinking Fund securities 780,000
Dec. 20, 2017
Feb. 12, 2018
Sinking Fund Cash
Sinking Fund Income
No entry
December 31, 2018
195,000
195,000
Sinking Fund Cash 270,000
Sinking Fund Income.
270,000
Sinking Fund Cash 2,250,000
Loss on sale
220,000
Sinking Fund Securities
2,470,000
Bonds payable
3,000,000
Sinking Fund cash 3,000,000
Cash
534,000
Sinking Fund Cash 534,000
Exercise 2. (ULO f) (Adapted Valix 2017 page 983) Donato Company and the
trustee provided the following transactions in chronological order in connection with
a sinking fund:
1. Cash contribution to the sinking fund, 1,600,000.
2. Acquisition of securities at par by the trustee, 1,120,000.
3. The trustee received interest on the securities, 96,000.
4. The trustee paid expenses of 48,000.
5. The trustee sold the securities for 1,280,000 plus accrued interest, 16,000.
6. The trustee rendered a report to the entity.
7. The trustee paid bonds payable of 1,600,000 and interest of 160,000.
8. The trustee remitted the remaining cash to the entity.
Answer
1. Sinking fund trustee
Cash
1,600,000
1,600,000
2. Sinking Fund expense 48,000
Sinking Fund Trustee 224,000
12
Sinking
Fund income
112,000
Gain
160,000
Entry from 3-5
3. Bonds payable
1,600,000
Interest expense 160,000
Sinking Fund trustee 1,760,000
Entry for # 7.
4. Cash 64,000
Sinking fund trustee
Entry for no. 8
64,000
Exercise 3. (ULO F) On July 1, 20A, Jojo company wants to accumulate fund of
2,800,000 at the end of year 4.
The entity plans to make four equal annual deposits in a fund that will earn interest
at 10% compounded annually.
The following are the relevant factors at 10%:
Future amount of ordinary annuity of 1 at 10% for 4 periods
Future amount of annuity in advance of 1 at 10% for 4 periods
Future Value of 1 at 10% for 4 periods
?
4.6410
5.1051
Required: In each cases, a. Compute the annual deposit to the fund; and b. Prepare
a schedule of fund accumulation.
Case a. The first annual contribution is made on July 1, 20A. (In advance)
Case b. The first annual contribution is made on June 30, 20B. (At the end)
Case c. The one time contribution is made on July 1, 20A.
Answer
Case a
2,800,000/5.1051
(b) Schedule of accumulation
Date
Annual contribution
Balance
July 1/20A
548,471
Jul 1/20B
548,471
Jul 1/20C
548,471
Jul 1/ 20D
548,471
June 30/ 20E
=
548,471 (a)
Interest
548,471
54,847
1,151,789
115,179
1,815,439
181,544
2,545,454
254,546
2,800,000
Case b
2,800,000/4.640
=
603,448 (a)
(b) Schedule of accumulation
Date
Annual Contribution(end)
Interest
balance
June 30, 20B
603,448
603,448
13
Fund
Fund
June 30,
20C
603,448
60,345
June 30, 20D
June 30, 20E
1,267,241
603,448
603,448
126,724
199,139
Case c
2,800,000/1.4641
(b) Schedule of accumulation
Date
Annual Contribution
balance
July 1, 20A
June 30, 20B
June 30, 20C
June 30, 20D
June 30, 20 E
=
1,997,413
2,800,000
1,912,438
Interest
Fund
1,912,438
191,244
2,103,682
210,368
2,314,050
231,405
2,545,455
254,545
2,800,000
Exercise 4. (ULO f) Contingency fund, Preference share redemption fund.
Marlon Company had the following funds for different purposes established on
January 1 of the current year:
Preference share redemption fund
1,500,000
Contingency Fund
750,000
Insurance fund
9,000,000
The contingency fund was set because the company was contingently liable for
damages by virtue of a breach of contract.
On July 1 of the current year, a building costing 7,500,000 with accumulated
depreciation of 3,000,000 is destroyed due to fire.
The construction of a new building cost the Marlon company 12,000,000.
insurance fund was spent for this purpose.
The
On Dec. 15 of the same year, Marlon company lost against the complainant for
breach of contract and able to pay the damages from its contingency fund.
At the end of the year, the company redeemed 25,000 preference shares with par
value of P50 at P53 per share.
Required: Prepare the necessary entries for the following transactions above.
Answer:
July 1,
Loss on Fire
Accumulated Depreciation
Building
Building
Insurance Fund
14
4,500,000
3,000,000
7,500,000
12,000,000
9,000,000
Cash
3,000,000
Loss on lawsuit
750,000
Contingency Fund
750,000
Preference shares(25,000*50)
1,250,000
Retained Earnings
75,000
Preference share redemption fund 1,325,000
Exercise 5. ( ULO g) (Adapted Valix 2017 page 984) Louie company insured
the life of the president for 2,000,000, the entity being named as the beneficiary.
The annual premium is 72,000. The policy was dated April 1, 20A and carried the
following cash surrender value:
End of policy year
Cash surrender value
April 1, 20B
April 1, 20C
April 1, 20D
72,000
April 1, 20E
100,800
April 1, 20F
139,200
The entity followed the calendar year as the accounting period. The president died
on July 1, 20E and the face of the policy was collected on July 31, 20E.
Required: Prepare journal entries from April 1, 20A to July 31, 20E.
Answer:
April 1, 20B Life insurance expense
Cash
72,000
72,000
December 31, 20B Prepaid insurance 18,000
Life insurance
January 1, 20C
April 1, 20C
Life insurance expense
Prepaid insurance
Life insurance expense
Cash
18,000
18,000
18,000
72,000
72,000
December 31, 20C Prepaid life insurance
Life Insurance expense
18,000
18,000
January 1, 20D
18,000
18,000
April 1, 20D
Life insurance expense
Prepaid life insurance
Life insurance expense
Cash
72,000
72,000
December 31, 20D Prepaid life insurance
Life insurance expense
15
18,000
18,000
Life insurance expense 18,000
Prepaid life insurance
April 1, 20E
Life insurance expense
Cash
Jan. 1, 20E
18,000
72,000
72,000
Cash Surrender value
Life insurance expense
Retained earnings
72,000
6,000
66,000
July 1, 20E
Cash Surrender Value
7,200
Life insurance expensee 7,200
72,000-100,800=28,800*3/12=7,200
July 31, 20E
Cash
72,000*9/12
2,000,000
Cash surrender value
Life insurance expense
79,200
54,000
Gain on life insurance settlement
In a Nutshell
1,866,800
In minimum of 50 words, explain the importance and usefulness of putting up of a
fund in the viewpoint of the business and also in your own personal life or as an
advice to your friends, parents or even to your classmates.
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16
Government Grant
Let’s Check (ULO m)
Activity 1. Now that you know the most essential knowledge in the study of
government grant , let us try to check your understanding of the topic. In each of
the questions, choose the letter of your choice.
__True_1. Government grant shall be recognized when there is reasonable
assurance that the entity will comply with the conditions of the grant.
__False 2. Government grant in recognition of specific costs is recognized as
income immediately.
___True_3. Government grant related to non depreciable asset that requires
fulfilment of certain conditions should be recognized as income over the periods
which bear the cost of meeting the conditions.
False__ 4. A government grant that becomes repayable shall be accounted for as
change in accounting policy.
_False__5. Repayment of grant related to an asset shall be recorded by reducing
the deferred income balance to zero if the deduction from asset approach is used.
False_ Government assistance includes all of the following:
a. Free technical advice
b. Provision of guarantee
c. Government procurement policy
d. Improve irrigation water system for the benefit of an entire local
community.
False_ 6. A forgivable loan from the government or the benefit of a government
loan at NIL or below market interest rate is accounted for as neither government
grant nor assistance
_False 7. In the case of grant related to income, the accounting treatment
prescribed is credit the grant to retained earnings.
True__ 8. Capitalization of borrowing cost is suspended during temporary period of
delay.
False_ 9. The period of time during which interest must be capitalized ends when
the asset is sold, abandoned or fully depreciated.
True_10. Interest earned on specific borrowing must be credited to interest
income.
Let’s Analyze
Activity 1. Getting acquainted with the essential knowledge in the study of
government grant is not enough, what also matters is you should also be able to
solve and prepare entries transactions affecting government grant. Now, I will
require you to answer the following problems.
17
Problem 1.
Galendez Company received the following grants on January 1, 201Q:
1. A grant of 48,000,000 to compensate for costs to be incurred in planting
trees over a period of 5 years whereby the entity will incur such costs at
1,600,000 for 2017; 3,200,000 for 2018; 4,800,000 for 2019; 6,400,000 for
2020 and 8,000,000 for 2021.
Answer:
Year 11,600,000 1.6/24
=
3,200,000
Year 23,200,000 3.2/24
* 48,000,000
=
6,400,000
Year 3 4,800,000 4.8/24
=
9,600,000
Year 4 6,400,000 6.4/24
=
12,800,000
Year 58,000,000 8/24
=
16,000,000
24,000,000
Cash
48,000,000
Deferred Grant income
48,000,000
Environmental costs
Cash
1,600,000
1,600,000
Deferred Grant income
Grant income
3,200,000
Environmental costs
Cash
3,200,000
3,200,000
Deferred grant income
Grant Income
6,400,000
3,200,000
6,400,000
2. A tract of land in Mindanao with a fair value of 21,600,000 by the national
government. The grant requires Galendez company to construct a refinery
on the site estimated at a cost of 36,000,000, the useful life of which is 20
years.
Answer: Year 1
Land 21,600,000
Deferred Grant income
21,600,000
Refinery
36,000,000
Cash
36,000,000
Depreciation expense
1,800,000
Accumulated depreciation
1,800,000
Deferred grant income
Grant Income
1,080,000
1,080,000
18
Year 2:
Depreciation expense
1,800,000
Accumulated depreciation
1,800,000
Deferred grant income
Grant income
1,080,000
1,080,000
3. Galendez Company purchased a machine for 6,750,000 on January 1, 20Q.
The entity received a government grant of 1,125,000 in respect of this asset.
The policy is to depreciate the asset over 5 years on a straight line basis and
to treat the grant as deferred income. On Jan. 1, 20S, the grant became fully
repayable because of non compliance with conditions.
Answer: Deferred income approach
Machine
6,750,000
6,750,000
Cash
6,750,000
(2,700,000)
4,050,000
Cash 1,125,000
Deferred grant income
1,125,000
Depreciation expense
1,350,000
Accumulated depreciation
1,350,000
Deferred grant income
Grant income
225,000
225,000
December 31, 20R
Depreciation expense
1,350,000
Accumulated depreciation
1,350,000
Deferred grant income
225,000
Grant income
225,000
January 1, 20S
Deferred Grant income
675,000
Loss on GG
450,000
Cash
1,125,000
Deduction from asset approach
Machine
6,750,000
Cash
6,750,000
Cash 1,125,000
Machine
1,125,000
6,750,000
(1,125,000)
(2,250,000)
1,125,000
(450,000)
4,050,000
Depreciation expense
1,125,000
Accumulated depreciation
December 31, 20R
19
1,125,000
Depreciation expense
1,125,000
Accumulated depreciation
1,125,000
January 1, 20S
Depreciation expense
450,000
Machinery
1,125,000
Accumulated depreciation
450,000
Cash
1,125,000
Required: Prepare the entries in connection with the grants received above for 2
years. Show the necessary solution. In case 3, present you answer for the two
approaches.
Problem 2.
On January 1, 20Q, the city government agreed to provide Probity Company with a
5,000,000 three-year, zero-interest loan evidenced by promissory note.
The prevailing rate of interest for a loan of this type is 10% and the present value of
1 at 10% for three years is .75.
a. What is the journal entry to record the transaction on Jan. 1, 20Q?
b. What is the interest expense for 20Q?
c. What is the deferred grant income on December 31, 20Q?
d. What is the carrying amount of the note payable on December 31, 20R?
Answer:
Cash
5,000,000
Discount on N/P
1,250,000
N/P
5,000,000
Deferred grant income
1,250,000
Interest expense
375,000
Discount on N/P
375,000
Deferred grant income375,000
Grant income
Year 2
375,000
Interest expense 412,500
Disc. On N/P
412,500
Deferred Grant income
Grant income
Year 3Interest expense
412,500
412,500
462,500
Disc. On N/P
Deferred grant income
462,500
462,500
20
Grant income
5,000,000 *.75=
462,500
3,750,000
375,000
412,500
462,500
1,250,000
875,000
462,500
-
3,750,000
4,125,000
4,537,500
5,000,000
In a Nutshell (ULO m and n)
With the happenings in the world in this year 2019 and 2020, give an example of
government grant received by the Philippines from other countries and or an
individual/company receiving government grant from the Philippine Government.
Explain its accounting treatment.
Be able to explain in not less than 50 words.
21
Let’s Check
Fill in the blanks (ULO a and d): On the space provided for, write the answer on
the items described or defined.
1. _Gain________ from disposal of investment property is the excess of the net
disposal proceeds after deducting the carrying amount of the investment
property.
2. _Revaluation The account used for the difference between the carrying
amount and fair value if owner-occupied property is to be transferred as
investment property under fair value model.
3. Gain from change in fair value When the fair value of the investment
property increased compared to its carrying amount at the start of the year,
what is the treatment of the amount of difference?
4. ____________When cost model is used by an entity, transfers between
investment property, owner-occupied property and inventory shall be made
at this amount.
5. __Income statement_ When an investment property is carried at fair value,
any changes in the fair value is reported in _____________ statement.
6. ____Gain______ from disposal of investment property is the excess of the net
disposal proceeds after deducting the carrying amount of the investment
property.
7. _Fair value model Under this model, transfers from investment property shall
be made at fair value.
8. _Cost Model___This subsequent measurement of investment property carry
the investment at cost less accumulated depreciation and accumulated
impairment losses with Fair value disclosure.
9. Investment Property It refers to land or buildings held primarily to earn
rentals or for capital appreciation.
10.Change of use Examples of these are commencement of owner occupation,
Commencement of development with a view to sale, end of owneroccupation, commencement of an operating lease from owner-occupied
property to investment property.
True or False: Write true if the statement is correct and false if the
statement is wrong.
11.Property that is leased to another entity under a finance lease is an example
of investment property. False?
12.Property held for future use as owner occupied property is an example of
investment property. False
13.An investment property held by a lessee as a right of use asset shall be
recognized in accordance with IFRS 16. True
14.The cost of an investment property is not increased by start up costs (unless
they are necessary to bring the property to the condition necessary for it to
be capable of operating in the manner intended by management. True
15.The cost of an investment property does include operating losses incurred
before the investment property achieves the planned level of occupancy.
False
22
16.The cost of
an
investment
property held by a
lessee as a right-of-use asset is measured initially at cost in accordance with
IAS 40. False
Let’s Analyze
Activity 1. (ULO c) Getting acquainted with the essential knowledge in the study
of accounting for investment property, what also matters is you should be able to
solve and journalize transactions on a problem situation. Now, I will require you to
prepare journal entries on the following problems and also answer questions being
asked.
This will be graded for class assignments/seatwork. I will accept handwritten
solutions and answers only uploaded through LMS.
Exercise 1. Rustom company purchased an investment property on January 1, 20A
for a cost of 4,400,000.
The property had a useful life of 40 years and on December 31, 20C had a fair value
of 6,000,000.
On December 31, 20C the property was sold for net proceeds of 5,800,000.
The entity used the cost model to account for the investment property.
a.
What is the gain or loss to be recognized for 20C regarding the disposal of
the investment property?
b. Prepare the entry to record the disposal under cost model and revaluation
model
Answers:
a. 4,400,000/40
=
Net proceeds
Carrying amount
Gain on disposal
110,000
*
3
=
330,000
5,800,000
(4,070,000) (4,400,000-330,000)
1,730,000
b. Cost Model entry upon disposal
FV
model
entry
upon
disposal
Cash
5,800,000
Cash
5,800,000
Accum. Dep’n 330,000
Loss on disposal 200,000
Investment Property 4,400,000
Investment
property 6M
Gain on disposal 1,730,000
Exercise 2. Gallery Company venture into construction of high rise building for the
purpose of earning rentals by letting out space to business executives in the area.
23
The construction of
the building has
been completed on January 1, 20A for a total cost of 80,000,000. The useful life of
the property is for 25 years with a residual value of 8,000,000. An independent
valuation expert provided the following fair value at each subsequent year-end:
December 31, 20A
88,000,000
December 31, 20B
84,800,000
December 31, 20C
96,000,000
Required: Prepare journal entries for 20A, 20B and 20C:
a. The investment property is subsequently measured at cost model;
b. The investment property is subsequently measured at revaluation model
Answer
A. Cost Model
20A
Investment property
80,000,000
Cash
B. Revaluation Model
20A
Investment property
80,000,000
80,000,000
Cash
80,000,000
Depreciation expense 2,880,000
Investment property 8,000,000
Accumulated depreciation
2,880,000
Gain from change in
FV8,000,000
20B
Depreciation expense 2,880,000
Loss from change in FV
3,200,000
Accumulated Dep.
2,880,000
Investment property
3,200,000
20C
Depreciation expense 2,880,000
Investment property 11,200,000
Accum. Dep.
2,880,000
Gain from change in
FV 11,200T
Exercise 3. (Adapted Valix 2015 volume 1 page 929) Considerate company
has a single investment property which had an original cost of 11,600,000 on
January 1, 20A. On Dec. 31, 20A the fair value was 12,000,000 and on Dec. 31, 20B
the fair value was 11,800,000. On acquisition, the property had a useful life of 40
years.
What is the entry to recognize the expense in profit or loss for the year ended
December 31, 20B under the fair value model and cost model?
Answer
Cost Model
Fair Value Model
Depreciation expense 290,000
200,000
Loss from change in FV
24
Accumulate
d dep. 290,000
Investment property
200,000
In a Nutshell (ULO b)
Using the problem below, answer in paragraph form, observe correct grammar and
in minimum of 50 words.
Problem: Dylan Company owned three investment properties
details:
Initial cost FV 12/31/20B
Property 1
2,430,000 2,880,000
Property 2
3,105,000 2,745,000
Property 3
2,970,000 3,465,000
with the following
FV 12/31/20C
3,150,000
2,565,000
3,240,000
Each property was acquired in 20B of January with a useful life of 25 years. The
accounting policy is to use the fair value model for investment properties.
Dylan Company is seeking for your advice as to how they will present the carrying
amount of the investment property on Dec. 31, 20B and Dec. 31, 20C.
Give a clear presentation to Dylan Company as to the choices available in
accordance with Standard 40.
Answer: elaborate explanation includes the entries…….
Since FV model is used, the carrying amount on December 31, 20B is equal
to its FV at that date which is 9,090,000.
An also, the balance on December 31, 20C shall be its FV at that date
which is 8,955,000.
25
Property, Plant and Equipment
Let’s Check (ULO j)- August 28, 2020
True or False: Write true if the statement is true and false if the statement is wrong.
True 1. In an intallment basis where the cash price is not available, the cost of the
asset is equal to the present value of all payments using an implied interest rate.
False 2. In an instalment basis where the cash price is available, the difference
between the face value of the note and the present value of the note is regarded as
interest expense amortized by the effective interest method over the credit period.
False 3. Extraordinary repairs are expensed as incurred.
False 4. When land and building are purchased at a single cost, and the building is
usable, the cost is allocated between land and building on the basis of their
carrying value.
False 5.
Ventilating system, lighting system, elevator if installed during
construction, it is charged to the building improvements account.
_False 6. When land and building are purchased at a single cost, whether the
building is usable or not, the full cost is charged to land.
_True 7. Movable building fixtures is charged to furniture and fixtures.
True 8. If part of the blue print, sidewalks, pavements, parking lot, driveways
should be charged to building.
False 9. Any expenses in relation to the donated asset is charged or deducted from
the donated asset.
False_10. Exchange involves a significant amount of cash and involves a nondealer acquiring the asset from a dealer.
_True 11. Cost of testing whether the asset is functioning properly, after deducting
the net proceeds from selling any items produced while bringing the asset to that
location and condition is an example of capitalizable cost of the property, plant and
equipment.
_False 12. Cost of introducing a new product or service and cost of opening a new
facility are costs that are capitalizable for property, plant and equipment.
False 13. Depreciation is no longer provided if the fair value of the asset exceeds
its carrying amounts and the asset’s residual value does not exceed its carrying
amount.
_False 14. Depreciation of an asset continues for a property that is classified as
held for sale.
_True_ 15. Depreciation is provided for an item of property that is idle, or retired
from active use unless it is fully depreciated. True
_False_16. The cost of an item of property, plant and equipment comprises all of
the following:
a. Purchase price
b. Import duties and non-refundable purchase taxes
26
c. Any cost directly attributable in bringing the asset to the location and
condition for the intended use.
d. Initial estimate of the cost of dismantling and removing the item and
restoring the site, the obligation for which the entity does not incur when the
item was acquired.
False 17. All of the following are an essential characteristic of property, plant and
equipment
a. The property, plant and equipment are tangible assets.
b. The property, plant and equipment are used in production or supply of goods
and services, for rental purposes and for administrative purposes.
c. The property, plant and equipment are expected to be used over a period of
more than one year.
d. The property, plant and equipment are subject to depreciation.
False 18. Costs directly attributable to bringing the asset to the location and
condition for the intended use include cost of employee benefits not arising directly
from acquisition of property, plant and equipment.
__True_19. Cost of opening a new facility should be expensed immediately.
__True_20. Write off is the term that best describes the removal of an asset from
the statement of financial position.
__False 21. The single cost of acquiring land and usable old building is charged to
the land only.
_False_ 22. The cost of land typically includes all of the following:
a. Grading, filling, draining and clearing cost.
b. Special assessment for street light and drainage system.
c. Private driveway and parking lot.
d. Assumption of any lien on the property.
False 23. All of the following costs relating to property, plant and equipment
should be capitalized.
a. Replacement of roof of building every 15 years.
b. Cost of site preparation.
c. Installation and assembly costs.
d. Replacement of small spare parts annually.
_False_24. The term “betterment” refers to an expenditure made to help insure
continuity of service capacity.
_True__25. All type of expenditure occurs when an entity installs a higher capacity
boiler to heat the plant, except letter b.
a. Rearrangement
b. Ordinary repairs and maintenance
c. Addition
d. Betterment
27
Let’s Analyze
Activity 1. Getting acquainted with the essential terms in the study of property,
plant and equipment may not be enough, what also matters is developing an ability
to analyze, solve and provide journal entries on transactions of a business affecting
its property, plant and equipment. Now, I will require you to answer the following
problems.
Problem 1 –Alena Company asks for your expertise in the recording of its
acquisitions of property during its first year of operation.
a. Purchased land and building for 9,000,000 at a lump sum price. The building
had a fair value of 6,000,000 and land of 1,500,000.
Answer:
Land
1,500,000
=
1,800,000
Building
6,000,000 *
9,000,000 =
7,200,000
7,500,000
Land
1,800,000
Building
7,200,000
Cash
9,000,000
b. Alena company purchased a machine at an invoice price of 700,000, 2/10, n/30.
It made the payment within the discount period and the entity uses the gross
method of recording.
Answer:
Machine
700,000
Accounts payable
700,000
Accounts payable
Machine
Cash
700,000
14,000
686,000
c. Alena company purchased furnitures and fixtures at an invoice price of
1,200,000, 2/10, n/30. The entity uses the net method of recording and paid the
account beyond the discount period.
Answer:
Furnitures and fixtures
1,176,000
Accounts payable
1,176,000
Accounts payable
Purchase discount lost
Cash
1,176,000
24,000
1,200,000
d. Alena company purchased a machine at an instalment price of 2,100,000. A
300,000 down payment is needed and the balance payable thereafter in 3 equal
28
annual instalments. The cash price of the machine is 1,740,000. The company
issued a 1,800,000 promissory note for the balance.
Answer:
Machine
1,740,000
Disc. On N/P 360,000
N/P
1,800,000
Cash
300,000
N/P
600,000
Cash 600,000
Interest expense
Disc. On N/P
N/P
600,000
Cash 600,000
600,000
Cash
600,000
Interest expense 120,000
Disc. On N/P
120,000
Interest expense 60,000
Disc. On N/P
60,000
N/P
1800,000
1,200,000
600,000
3,600,000
18/36 *
12/36 *
6/36 *
360,000
360,000
360,000
=
=
=
180,000
180,000
180,000
120,000
60,000
360,000
e. Alena company purchased computer at an installment price of 2,100,000; down
payment 300,000; balance payable in 3 equal annual instalments and a promissory
note has been issued by the company. The implied interest rate is 10%.
The
present value factor of 1 at 10% for 3 periods is 2.487.
Answer:
Computer equipment
1,792,200
600,000
*
2.487=1,492,200
Disc. On N/P
307,800
-1,800,000
Cash
300,000
307,200
N/P
1,800,000
N/P
Cash
600,000
600,000
Interest expense
Disc. On N/P
Cash
600,000
600,000
Interest expense
Disc. On N/P
Cash
600,000
600,000
Interest expense
Disc. On N/P
N/P
N/P
Table of Amort.
600,000
600,000
149,220
104,142
1,492,200
1,041,420
545,562
450,780
495,858
29
600,000
54,438
545,562
-
Required: 1. From case a to e, prepare the journal entry for the company
and the subsequent payments. Show the necessary solutions.
Problem 2.Pirena
year essential for
bookkeeper in the
industry they have
company had the following acquisitions of property during the
its company operations. You are being hired to assist the
recording of the transactions as they are new in the business
chose to expand with.
a. Pirena acquired land to be used as their office site by issuing 15,000 shares with
par value of 50. The fair value of the land is 1,000,000 and the shares are quoted
at 95.
Answer: Land
1,000,000
Share capital
750,000
Share premium
250,000
b. Pirena company acquired a building as manufacturing plant through the issuance
of bonds having a face value of 2,000,000. At the time of acquisition, building had
fair value of 2,400,000 and the bonds are quoted at 116.
Answer:
Building
2,320,000
B/P
2,000,000
Premium on B/P
320,000
c. Pirena company has an investment with carrying amount of 250,000. It is
exchanged for an equipment with a fair value of 275,000. At the time of exchange,
the investment has a fair value of 265,000.
Answer:
Equipment 265,000
Investment
250,000
Gain on exchange
15,000
d. Pirena and Ibrahim company are fuel oil distributors. To facilitate the delivery of
oil to their customers, Pirena and Ibrahim exchanged ownership of 1,080 barrels of
oil without physically moving the oil.
Pirena Company paid Ibrahim Company 270,000 to compensate for a difference in
the grade of oil.
The configuration of cash flows from the asset received is not expected to be
significantly different from the configuration of the cash flows of the asset
exchanged.
On the date of exchange, cost and market value of the oil were as follows:
Pirena Company
Ibrahim Company
Cost
900,000
1,260,000
Market
1,080,000
1,350,000
30
Answer:
Pirena Company
Oil inventory 1,170,000
Oil inventory-old
Cash
900,000
270,000
e. Pirena company had a delivery truck traded with Sincere company. Pirena paid
150,000 cash for a tow truck owned by Sincere company.
The delivery truck of Pirena had an original cost of 2,100,000 and accumulated
depreciation of 1,200,000. The estimated fair value was 1,350,000.
The entity estimated the fair value of the tow truck received to be 1,500,000. The
transaction had commercial substance.
Answer:
Accumulated Depreciation
1,200,000
Tow Truck
1,500,000
Delivery Truck
2,100,000
Cash
150,000
Gain on exchange 450,000
f. The Company traded its old equipment for a new one at Lim Enterprises. The
following data relates to the old and the new.
OldEquipment
New Equipment
Cost
2,800,000
List price
4,000,000
Accumulated Dep. 2,000,000
Trade
in
value
of
old
(1,000,000)
Carrying amount 800,000
Cash payment
3,000,000
Fair value
700,000
Trade in value
1,000,000
Required: Prepare the entries for each case above using the preferred accounting
treatment.
Answer:
Equipment new
3,700,000
Accumulated depreciation
2,000,000
Loss on exchange
100,000
Cash
3,000,000
Equipment old
2,800,000
Problem 4.
31
Lee Company purchased land for 4,000,000 as a factory site. There was a small
office building on the land having a fair value of 1.400,000 which the entity will
continue to use with some modification and renovation.
The entity decided to construct a factory building and incurred the following costs:
Materials and supplies
6,000,000
Excavation
200,000
Labor on construction
5,000,000
Cost or remodelling old office building
400,000
Imputed interest on corporation’s own money used during construction 240,000
Cash discounts on materials purchased
120,000
Supervision by management during construction
140,000
Compensation insurance premiums for workers
40,000
Payment of claim for injuries not covered by insurance
50,000
Clerical and other expenses during construction
60,000
Paving of streets and side walks
80,000
Plans and specifications
280,000
Legal cost of conveying land
20,000
Legal cost of injury claim
30,000
Saving on construction
400,000
Required: Compute for the cost of the land, office building and factory building.
Asnwer:
Land
building
Lumpsum price
2,600,000
Materials and supplies
Excavation
Labor on construction
Remodeling
Discounts on materials
Supervision
Insurance prem
Clerical
Plans & spec
Legal cost
20,000
2,620,000
Office building
Factory
1,400,000
6,000,000
200,000
5,000,000
400,000
(120,000)
140,000
40,000
60,000
280,000
_______________________________
1,800,000
11,600,000
Problem 5.(Adapted C. Valix, J. Peralta, C. Valix Financial Accounting) page
1191
Rodel Company incurred the following expenditures related to land and building:
Cash paid for land and dilapidated building
3,000,000
Removal of old building to make room for construction of a new building
150,000
Payment to tenants for vacating old building
45,000
32
Architect fee for new building
600,000
Building permit fro new construction
90,000
Fee for title search
30,000
Survey before construction of new building
60,000
Excavation before new construction
300,000
New building constructed
18,000,000
Assessment by city for drainage project
15,000
Cost of grading, levelling and land fill
135,000
Driveways and walks to new building from street (part of building plan)
120,000
Temporary quarters for construction crew
240,000
Temporary building to house tools and materials
180,000
Cost of changes during construction to make new building more energy efficient
150,000
Cost of window broken by vandals
75,000
Required:Compute for the cost of the land and costs chargeable to the new
building.
Answer:
Building
Land
Cash paid for land and dilapidated building
3,000,000
Removal of old building
150,000
Payment to tenants for vacating old building
45,000
Architect fee for new building
600,000
Building permit fro new construction
90,000
Fee for title serach
30,000
Survey before construction of new building
60,000
Excavation before new construction
300,000
New building constructed
18,000,000
Assessment by city for drainage project
15,000
Cost of grading, levelling and land fill
135,000
Driveways and walks to new building
120,000
Temporary quarters for construction crew
240,000
Temporary building to house tools and materials
180,000
33
Cost of changes during construction
150,000___________________
19,875,000
3,240,000
Problem 6. Adapted C. Valix, J. Peralta, C. Valix 2017 page 1216.
Khalil Company is installing a new equipment at the production facility and incurred
the following costs:
Cost of equipment per supplier’s invoice
4,500,000
Initial delivery and handling cost
360,000
Cost of site preparation
1,080,000
Consultants used for advice on the acquisition of equipment
1,260,000
Interest charges paid to supplier for deferred credit
360,000
Estimated dismantling cost to be incurred as required by contract
540,000
Operating losses before commercial production
720,000
Determine the amount of capitalized cost of the equipment.
Answer:
Cost of equipment per supplier’s invoice
4,500,000
Initial delivery and handling cost
360,000
Cost of site preparation
1,080,000
Consultants used for advice on the acquisition of equipment
1,260,000
Estimated dismantling cost to be incurred as required by contract
540,000
7,740,000
Problem 7.Adapted C. Valix, J. Peralta, C. Valix 2017 page 1221.
Aquil Company acquired a machine and incurred the following costs:
Cash paid for machine, including VAT of 96,000
1,075,200
Cost of transporting machine
36,000
Labor cost of installation by expert filter
60,000
Labor cost of testing machine
48,000
Insurance cost for the current year
18,000
Cost of training for personnel who will use the machine
30,000
Cost of dafety rails and platform surrounding machine
72,000
Cost of water device to keep machine cool
96,000
Cost of adjustment to machine to make it operate more efficiently
90,000
Estimated dismantling cost to be incurred as required by contract
78,000
What total amount should be capitalized as cost of the machine?
Answer:
Cash paid for machine, including VAT of 96,000
Cost of transporting machine
34
979,200
36,000
Labor cost of installation by expert filter
60,000
Labor cost of testing machine
48,000
Cost of dafety rails and platform surrounding machine
72,000
Cost of water device to keep machine cool
96,000
Cost of adjustment to machine to make it operate more efficiently
90,000
Estimated dismantling cost to be incurred as required by contract
78,000
1,459,200
In a Nutshell
In this section, it’s your turn to explain in your own understanding in minimum of 50
words.
Your friend who is working for a small company in Davao City is having confusion in
the recording of its newly purchased equipment for cash where they availed of a
cash discount and in another purchase of machinery where they opt to purchase in
deferred terms instead of purchasing it at the cash equivalent price.
Another issue raised is on an injury on one of their labourer during the construction
of their small office building where their company have not taken an insurance
for/during the construction.
Your intelligent advice is needed.
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35
36
Depreciation
Let’s Check
Problem 1. Sheena Company had the following transactions regarding its property, plant and
equipment.
a. A machine is purchased on May 1, 2017 costing 1,000,000 with useful life of 5 years and a
residual value of 100,000. The company uses the straight line method.
Answer:
Year 1
Year 2
Year 3
Year 4
Year 5
Dep
Accum Dep
180,000
180,000
180,000
180,000
180,000
180,000
360,000
540,000
720,000
900,000
CA
1,000,000
820,000
640,000
460,000
280,000
10000,000
b. On April 1, 2017, a machine costing 6,000,000 was purchased and the SYD method is used.
The useful life of the machine was 10 years with a residual value of 500,000.
Answer:
Year 2017
10/55 *
5500,000
=
1,000,000
* 9/12=750000
Year 2018
10/55 *
9/55 *
5,500,000
5,500,000
=
=
1,000,000
900,000
* 3/12 = 250,000
* 9/12= 675,000 925,000
Year 2019
9/55
8/55
*
*
5,500000
5,500,000
=
=
900,000
800,000
* 3/12=225,000
* 9/12=600,000
Year 2020
8/55
7/55
*
*
5,500,000
5,500,000
=
=
800,000
700,000
* 3/12= 200,000
*9/12= 525,000 725,000
Year 2021
7/55
6/55
*
*
5,500,000
5,500,000
=
=
700,000
600,000
* 3/12= 175,000
* 9/12 = 450,000 625,000
Date
Dep
A/D
12/31/17
12/31/2018
750,000
925,000
750,000
1,675,000
1
CA
6,000,000
5,250,000
4,325,000
825,000
12/31/2019
12/31/2020
12/31/2021
825,000
725,000
625,000
2,500,000
3,225,000
3,850,000
3,500,000
2,775,000
2,150,000
c. On January 1, 2017, purchased a machine for 1,600,000 used in a factory with a useful life of
5 years and a residual value of 80,000. The machine was depreciated by the double declining
balance method.
Answer:
1/5
2017
2018
2019
2020
2021
=
20%
*
640,000
384,000
230,400
138,240
127,360
2
=
40%
1,600,000
960,000
576,000
345,600
207,360
80,000
640,000
1,024,000
1,254,400
1,392,640
1,520,000
d. A machine purchased on March 1, 2017 for P8,000,000 has a production capacity over its
economic life of 4,000,000 in terms of units of products capacity to produce and 3,040,000 in
terms of service hours available for production. The residual value amounted to 400,000. Units
produced per year in terms of units and service hours worked are shown below:
Units produced
Service Hours worked
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
800,000
850,000
750,000
750,000
650,000
200,000
650,000
690,000
660,000
635,000
345,000
60,000
Answer Production method
8,000,000 – 400,000 / 4,000,000
=
Year 1
Year 2
Year 3
Year 4
Year 5
1,520,000
1,615,000
1,425,000
1,425,000
1,235,000
1,520,000
3,135,000
4560,000
5,985,000
7,220,000
8,000,000
6,480,000
4,865,000
3,440,000
2,015,000
780,000
Hours Worked method
7,600,000/3,040,000
=
Year 1
Year 2
1,625,000
1,725,000
1,625,000
3,350,000
2
2.5
1.9
8,000,000
6,375,000
4,650,000
Year 3
Year 4
Year 5
1,650,000
1,587,500
862,500
5,000,000
6,587,500
7,450,000
3,000,000
1,412,500
550,000
Required : In each of the following transactions, prepare the depreciation table for the first 5
years only. Follow the format suggested below:
Date
Depreciation expense
Accumulated Dep’n
Carrying Amount
Let’s Analyze
1. Happy Company owned a power plant which consisted of the following assets all acquired at
the beginning of current year.
Cost
Residual value
Useful life in years
Building
3,510,000
270,000
15
Machinery
1,188,000
108,000
8
Equipment
702,000
162,000
4
Required:
a. Compute the composite rate.
b. Compute the composite life
c. Prepare journal entry to record the depreciation for the current year following the
composite method.
d. Prepare journal entry to record the retirement of the machinery at the end of the 5th year
assuming the proceeds from retirement amount to 110,000.
e. Prepare journal entry to record the depreciation for the 6th year following the composite
method.
3
In a Nutshell
The problem (Adapted Financial Accounting Valix 2014 )In not less than 50 words, explain
the retirement of the hand tools using the two methods. Which method do you find easy and
why.
Grateful Company used a hand tool in the manufacturing activities. On January 1, year 1, there
are 320 of such tools on hand at cost of 200 each.
Acquisition and retirement during year 1 and year 2 are:
Acquisition cost
Retirement & retirement proceeds
Estimated value of tools at
year end
Year 1 160@300
120@50
80,000
Year 2 360@400
280@70
140,000
Retirement may be assumed to be on a first-in, first-out basis.
Required:
Prepare journal entries for year 1 and year 2 under
1. Retirement method
2. Replacement method
4
Impairment
Loss
Let’s Check (ULO g)
1. When allocating an impairment loss, such a loss should reduce the carrying amount of which
asset first? Goodwill
2. The allocation of an impairment loss is recognized for a cash generating unit
across the assets of the unit based on carrying amount except goodwill. (True or False)
3. Goodwill should be tested for impairment every 5 years. false
4. Impairment loss recognized for goodwill may be reversed through profit or loss. (True or
False)
5. Recoverable amount is the amount whichever is lower between value in use and fair value
less cost of disposal. (True or false) Higher
6. The carrying amount of an individual asset after the allocation of the impairment loss may
not be considered even if it falls below the highest of fair value less cost of disposal, value in
use and zero. (True or false) should be considered
7. All of the following are indications of impairment of asset. (True or False)
a. Decline in market value
b. Increases in interest rates
c. Obsolescence or physical damage
d. Economic performance of asset is worse than expected.
1. Value in use represents the total amount of the future cash flows to be derived from an asset
over its useful/economic life. (True or False) discounted
2. It refers to the smallest identifiable group of assets that generate cash inflows from
continuing use that are largely independent of the cash inflows from other assets or group
of assets. Cash generating unit
3. The excess of carrying amount over the recoverable amount of an asset is recognized as
loss on impairment. True
Let’s Analyze (ULO h)
Summer Company has four generating units. One CGU has been experiencing significant
losses in the prior years. Thus, it becomes necessary to determine impairment for the cash
generating unit. The assets of the CGU at carrying amount at the current year end are:
Cash
Accounts receivable
Inventory
Property, plant and equipment, net
Goodwill
8,000,000
16,000,000
24,000,000
40,000,000
4,000,000
It is reliably determined that the value in use of the cash generating unit at the current year-end
is 80,000,000.
Required:
1. Determine the impairment loss of the CGU.
2. Prepare journal entry to record the impairment loss.
5
Answer
1. 92,000,00080,000,000=12,000,000 Impairment loss
Impairment loss
12,000,000
Goodwill
4,000,000
Accounts receivable
1,600,000
Inventory
2,400,000
PPE
4,000,000
12,000,000-4,000,000=8,000,000*16/80=
8,000,000*24/80=
8,000,000*40/80=
1,600,000
2,400,000
4,000,000
In a Nutshell (ULO h) (Adapted)
One of the cash generating units of Serenity Company is the production of liquor.
At year end, the entity believed that the assets of the cash generating unit are impaired based
on an analysis of economic indicators.
The assets and liabilities of the cash generating unit at carrying amount at year end are:
Cash
3,000,000
Accounts receivable
4,500,000
Allowance for doubtful accounts
750,000
Inventory
5,250,000
Property, plant and equipment
16,500,000
Accumulated depreciation
3,000,000
Goodwill
2,250,000
Accounts payable
1,500,000
Loans payable
750,000
The entity determined that the value in use of the cash generating unit is 22,500,000. The
accounts receivable are considered collectible, except those considered doubtful.
Required:
You are being hired specifically for the purpose of helping the newly hired accounting clerk in
the liquor business because the owner is not agreeable on the allocation of impairment as
prepared for by the clerk. The owner questioned on cash being allocated an amount for
impairment by the clerk.
1. Determine the carrying amount of the cash generating unit.
2. Determine the impairment loss, if any, of the cash generating unit.
3. Prepare journal entry to record the impairment loss.
To help solve the matter, support your suggested allocation and entry with solution. As regards
cash to be allocated impairment loss or not, explain and cite an authoritative support.
6
Answer:
1. CA of CGU =
27,750,000
2. Impairment loss
=
27,750,000-22,500,000=5,250,000
3. Impairment Loss
5,250,000
Goodwill
2,250,000
Inventory
840,000
Acc. Dep- PPE
2,160,000
5,250,000-2,250,000=3,000,000*5,250/18750=840,000
3,000,000*13500/18750=2,160,000
7
Revaluation
Let’s Check
Problem 1 Alena Company applied revaluation accounting to plant asset with carrying amount
of 8,000,000 on January 1, year 1, useful life of 4 years and no residual value. Depreciation is
based on straight line method.
On December 31, year 1, independent appraisers determined that the asset has a fair value of
7,500,000.
Required:
1. What is the amount to record depreciation for Year 1?
2. What is the amount included in the journal entry to record the revaluation on December 31,
Year 2?
3. The financial statements for Year 1 shall include balance/carrying amount of plant asset on
January 1, year 2 amounting to _____________.
4. What is included in the journal entry to record depreciation for year 2?
Answer:
1. Dec. 31, year 1
Depreciation expense
2,000,000
Accumulated depreciation
2,000,000
8,000,000/4
2. Dec. 31, year 1 on Revaluation
8,000,000
10,000,000
2,000,000
(2,000,000)
(2,500,000)
500,000
6,000,000
7,500,000/.75
1,500,000
Plant Asset 2,000,000
Accumulated dep.
Revaluation surplus
500,000
1,500,000
3.
January 1, year 2 is the CA on Dec. 31 year 1
CA is 10,000,0002,500,000=7,500,000
4. Depreciation expense 2500,000
Accumulated depreciation
2,500,000
7,500,000/3=2,500,000
Problem 2. On January 1, year 1, Laagan Company owned a building with historical cost of
32,000,000 depreciated over a 40 year life on a straight line method. Revaluation model was
adopted by the entity in measuring its property, plant and equipment. The building has already
been revalued twice with the following fair values:
January 1, Year 2
37,440,000
January 1, Year 4
44,400,000
Required:
1. What is the revaluation surplus on January 1, Year 2?
2. What is the increase in revaluation surplus to be recognized as component of other
comprehensive income on January 1, year 4?
1. What is the revaluation surplus to be reported in the statement of changes on December 31,
Year 4?
Answer:
32,000,000
38,400,000
6,400,000
8
(800,000)
(960,000)
31,200,000
Entries:
160,000
37,440,000/.975
end of year 1 Dep. Expense
Acc. Dep
Jan. 1, year 2 Asset 6,400,000
Acc. Dep.
Revaluation surplus
6,240,000 answer 1
800,000
800,000
160,000
6,240,000
End of year 2 Dep. Expense 960,000
Acc. Dep.
960,000
37440,000/39=
960,000
R/S
160,000
RE
160T
End of year 3 Dep. Expense 960,000
Acc. Dep.
960,000
R/S
160,000
RE
160T
Jan. 1 year 4 37,440,000
(1,920,000)
35,520,000
46,800,000
2,400,000
44,400,000
9,360,000
480,000
8,880,000 answer 2
Asset 9,360,000
Acc. Dep.
480,000
Rev. surplus 8,880,000
Dec. 31, year 4
Dep. Expense 1200,000
Acc. Dep.
1200,000
R/S
R/S
44,400,000/31
160,000
RE
160,000
On First rev.
240,000
RE
240,000
On 2nd rev.
Revaluation surplus balance:
Credits
6,240,000+8,880,000=
Debits
160000*3+ 240,000 =
Balance
15,120,000
720,000
14,400,000
2.
Let’s Analyze
This problem will be graded and will form part of your 5% assignment and 10% accumulated
class participation/recitation. Submit with solution through LMS. I will accept photo upload of
answers which are handwritten only. Late submission will be given equivalent point deduction.
Hathoria company acquired a building on January 1, year 1 at a cost of 20,000,000. The
building has an estimated useful life of 6 years and residual value of 2,000,000.
9
The building was
revalued on January 1,
year 4 and the revaluation revealed replacement cost of 30,000,000, residual value of 4,000,000
and revised useful life of 8 years.
a. Prepare journal entry to record the revaluation.
b. Prepare journal entry to record annual depreciation for year 4.
c. Prepare journal entry to record the piecemeal realization of the revaluation surplus.
d. Prepare the solution to support your answer.
Answer:
20,000,000-2,000,000=18,000,000/6=3,000,000*3=9,000,000
Number 1
20,000,000
RV
(4,000,000)
16,000,000
3/6
(9,000,000)
Rem. 7,000,000
Asset
30,000,000
10,000,000
(4,000,000)
26,000,000
13,000,000
13,000,000
10,000,000
4,000,000
6,000,000
10,000,000
A/D
4,000,000
RS
6,000,000
Number 2
Depreciation expense
1,625,000
Accumulated Depreciation
Number 3
Revaluation surplus
750,000
Retained earnings
750,000
1,625,000
In a Nutshell
You are in conflict with your company boss named Haggorn in Khalil company as to work
related matters in presenting to the owner of the company on a certain sale of an asset which
has been revalued previously. Make a presentation to the owner that would support your stand
as to the recording of the said sale of the asset. Use the following data as your knowledge on
the said sale of the equipment. The data provided was on the date of revaluation:
Equipment
Residual value
Useful life in years
Age of the machinery
Accumulated depreciation
Cost
6,500,000
500,000
12
2
?
Replacement Cost
9,200,000
200,000
The selling price of the equipment yesterday (one year after revaluation) which your conflict has
arisen is 8,000,000.
10
Answer
6500,000500,000=6,000,000/12*2=1,000,000
2/12=.16666666
6,500,000
9,200,000
2,700,000
200,000
200,000
-
6,300,000
9,000,000
2,700,000
1,000,000
1,500,000
500,000
5,300,000
7,500,000
2,200,000
9,000,000/12*2=1,500,000
Asset 2,700,000
A/D
500,000
RS
2,200,000
After one year
Depreciation expense 750,000
Accumulated Dep.
Revaluation surplus
750,000
220,000
Retained earnings
220,000
Suggested entry when the asset is sold the day which is one year after revaluation:
Cash 8,000,000
A/D
2,250,000
Asset
9,200,000
Gain on sale 1,050,000
Revaluation surplus
1,980,000
Retained earnings
1,980,000
11
Wasting Asset
Let’s Check
Problem 1 Faith Company was engaged in the rock and gravel business. The following
transactions relate to the acquisition and development of an extensive gravel pit:
Year 1
Cost of acquisition and development
3,456,000
Estimated output
2,400,000 tons
Production
1,000,000 tons
Year 2
Additional development cost
1,764,000
Production
600,000 tons
Year 3
Additional development cost
600,000
New estimate of remaining output
2,500,000 tons
Production
700,000 tons
Required: Prepare journal entries for year 1, year 2 and year 3.
Answer:
2017 3,456,000/2,400,000=1.44*1,000,000
=
1,440,000
Rock and Gravel
3,456,000
Cash
3,456,000
Depletion
1,440,000
Accumulated Depletion
2018
Rock and Gravel
Cash
1,440,000
1,764,000
1,764,000
Depletion
1,620,000
Accumulated depletion 1,620,000
2019
Rock and gravel
Cash
600,000
600,000
Depletion 772,800
Accumulated Depletion 772,800
3,456,000+1764000-1,440,000
=
3,780,000/1400,000
=2.7*600,000
=1,620,000
3456,000+1754,000+600,000
= 5,820,000-1440000-1,620,000
=
2,760,000/2,500,000
=
1.104
Problem 2 Alpas company purchased a natural resource property for 9,000,000. The estimated
output was 1,500,000 tons. Mining equipment was acquired at the cost of 14,400,000. The
equipment has a useful life of 10 years but is capable of exhausting the resource in six to eight
years. Production is as follows:
1st year
300,000 tons
Second year
375,000 tons
3rd year
None
4th year
150,000
Compute the depletion and depreciation for each of the 4 years.
Answer: 14,400,000/1,500,000
=
9.6
Depletion
Year 1 9,000,000/1,500,000= 6*300,000=1,800,000
12
Depreciation
9.6*300,000=2,880,000
Year
2
9,000,000/1500
,000*375,000=2,250,0
00
Year 3
9.6*375,000=3,600,000
=
-
14400,000
- 2,880,000
- 3,600,000
=7,920,000/8=990,000
Year 4 9,000,000/1500,000*150,000=900,000
1,500,000-675,000=825,000
14,400,000-2880,000-3600,000—
990,000=6,930,000/825,000
=
8.4*150,000=1,260,000
Let’s Analyze
Exercise 1.On January 1, year 1, Kirk Company was organized with an authorized share capital
of 18,750,000 consisting of 75,000 of P250 par value, one half of which was immediately sold
for cash at 275 per share.
In February, the entity acquired a tract of resource land at a cost of 5,625,000 which was paid in
cash.
Also, the entity purchased for cash mining equipment of 1,500,000.
The geological survey of the resource property indicated an estimated content of 1,000,000
units.
During the year ended December 31 2017, the entity mined 90,000 units of which 85,000 units
were sold for a cash price of 125 per unit.
The entity paid the following during the year.
Mining labor and other direct costs
Administrative expenses
4,252,500
937,500
Required:
a. Prepare journal entries including adjustments to record the transactions.
b. Prepare an income statement for the year ended December 31, year 1.
c. Prepare a statement of financial position on December 31, year 1.
d. Compute the maximum dividend that can legally be declared by the entity on December
31, year 1.
e. Prepare journal entry assuming the maximum dividend is declared by the entity.
Answer:
Jan. 1, year 1
Feb. year 1
Cash 10,312,500
Share Capital 9,375,000
Share premium 937,500
Resource property
Cash
13
5,625,000
5,625,000
Mining Equipment
Cash
1,500,000
1,500,000
Cash 10,625,000
Sales
10,625,000
Depletion
506,250
Accumulated depletion
506,250
5625,000/1,000,000=5.625*90,000=506,250
Mining labor & Other Costs
Administrative expenses
Cash
4,252,500
937,500
5,190,000
Inventory 271,875
P/L
271,875
Depreciation 1500,000/1000000*90,000
Accumulated Depreciation
4252,500/90,000 =
47.25
1500,000/1000000=1.5
5625,000/1000000=5.625 54.375*5,000 =271,875
B. Income statement
Sales
Less:
135,000
937,500
4,252,500
506,250
(271,875)
Net Income
10,625,000
(5,559,375)
5,065,625
C. Statement of financial position
CA: Cash
8,622,500
Inventory
271,875
8,894,375
NCA:Resource Property 5,625,000
Less: A/D
(506,250)
14
135,000
135T
Mining
Property
1,500,000
Less: A/D
Total Assets
Share Capital
Share premium
R/E
(135,000) 6,483,750
15,378,125
9,375,000
937,500
5,065,625 15,378,125
D. RE
5,065,625
Cap. Liquidated 506,250
Dividends payable
5,571,875
In a Nutshell
Your boyfriend seeks for your expertise regarding a work related matter. He works for Love
company engaged in a business on exploration of natural resource property. He provided you
with the following balances at the end of the current year:
Wasting asset, at cost
16,000,000
Accumulated depletion
2,000,000
Share capital
40,000,000
Capital liquidated
1,440,000
Retained earnings
1,200,000
Depletion based on 50,000 units at 16 per unit
800,000
Inventory of resource deposit (5000 units)
320,000
He is confused on the company’s declaration of dividends of 1,600,000 which is more than its
retained earnings balance.
Answer
2,000,000
+
1,200,000
=
3,200,000
=
1,760,000
-
1,440,000
(80,000)
=
1,680,000 Max Dividend
15
Borrowing Cost Answer
Let’s Check (ULO o)
Activity 1. Now that you know most of the essential terms in the study of
accounting for borrowing costs, let us try to check your understanding of the topic.
True or False: Write true if
wrong, write false.
the statement is correct and if the statement is
________1. Borrowing costs are incurred in connection with borrowing of funds and
include all of the following:
a. Interest expense calculated using the effective interest method.
b. Finance charge in respect of finance lease.
c. Exchange difference arising from foreign currency borrowing to the extent
that the exchange difference is regarded as an adjustment to interest costs.
d. All of these are included in borrowing costs.
___True___2. If the qualifying asset is financed by specific borrowing, the
capitalizable borrowing cost is equal to actual borrowing cost incurred up to
completion of asset minus any investment income from the temporary investment
of the borrowing.
_False____3. If the qualifying asset is financed by general borrowing, the
capitalizable borrowing cost is equal to average expenditures on the asset
multiplied by a capitalization rate or actual borrowing cost incurred, whichever is
higher.
_False___4. Inventory that is manufactured or produced in large quantity on a
repetitive basis and takes a substantial period of time to get ready for use or sale
could be treated as qualifying asset for the purpose of capitalizing borrowing costs.
___False__5. Borrowing costs can be capitalized when the asset is a qualifying asset
and it is probable that the borrowing costs will result in future economic benefit to
the entity but the costs cannot be measured reliably.
_False_____6. All of the following should be considered a qualifying asset:
a. A power generation plant that normally takes two years to construct.
b. An expensive jet that can be purchased from a vendor.
c. A toll bridge that usually takes more than a year to build.
d. A ship that normally takes one to two years to complete.
__False__7. Cessation of capitalisation is provided for in IAS 23 par. 20
_True____8. The IAS 23 on borrowing cost does not deal with actual or imputed cost
of equity including preferred capital, not classified as a liability.
_False___9. An entity is required to apply the standard on borrowing cost to a
qualifying asset measured at fair value, for example a biological asset within the
scope of IAS 41.
__False__ 10. Paragraph 20 of IAS 23 provides that during extended period where
companies suspend active developments of a qualifying asset, it shall continue the
capitalisation of borrowing cost.
Let’s Analyze (ULO m)
Answer the following adapted problems:
Activity 1. Getting acquainted with the essentials in computing and accounting
treatment of borrowing costs, what also matters is you should also be able to solve
and analyze problems on borrowing costs. Now, I will require you to answer this
problem.
Problem 2 (Adapted C. Valix, J. Peralta, C. Valix 2017 page 1169
Mildred Company borrowed 5,200,000 on a 10% note payable to finance a new
warehouse which the entity is constructing for own use. The only other debt of the
entity is a 7,800,000, 12% mortgage payable on an office building. At the end of
the current year, average accumulated expenditures on the new warehouse totalled
6,175,000.
What amount of interest should be capitalized for the current year?
a. 520,000
b. 617,500
c. 637,000
d. 679,250
Problem 2.(Adapted C. Valix, J. Peralta, C. Valix 2017 page 1163)
On January 1, 2017, Sheena Company borrowed 2,800,000 at an interest rate of
12% specifically for the construction of a new building.
The actual interest cost on this specific borrowing was 336,000 but interest of
14,000 was earned from the temporary investment of the borrowing proceeds.
Sheena company also had the following other loans in 2017 for general purposes
but the proceeds were used in part for the construction of the building.
10% bank loan
12% long term loan
Principal
4,200,000
7,000,000
Interest
420,000
840,000
The construction began on January 1, 2017 and was completed on December 31,
2017. The expenditures on the construction were 2,800,000 on Jan. 1, 1,400,000
on March 31 and 4,200,000 on Sept.30.
Required: Compute the cost of the new building.
336,000-14000=
322,000
2800*12
=33,600,000
1,400,000*9
=12,600,000
4200,000*3
=12600,000
58,800,000/12=4900,000-2800,000=2100,000*.1125=236,250
1,260,000/11,200,000=.1125
= 2,800,000+1,400,000+4,200,000+ 322,000+ 236,250=8,958,250
Problem 3.(Adapted C. Valix, J. Peralta, C. Valix 2017 page 1163)Milott
Company had the following borrowings during 2017. The borrowings were made
for general purposes but the proceeds were used to finance the construction of a
new building.
12% bank loan
14% long term loan
Principal
3,900,000
6,500,000
Interest
468,000
910,000
The construction began on January 1, 2017 and was completed on Dec. 31, 2017.
Expenditures on the building were 2600,000 on June 30 and 1,300,000 on
December 31.
Required: Compute the cost of the building.
1378000/10,400,000
2600*6
=
1300*
=0
=
13.25 *
15,600,000/12
=
1300,000
=
172,250
1300,000
Answer= 172,250+2600,000+1300,000=4,072,250
Problem 4.(Adapted C. Valix, J. Peralta, C. Valix 2017 page 1164)
Jewelry Company had the following outstanding loans during 2017 and 2018.
Specific construction loan
3,600,000
10%
General loan
30,000,000
12%
The entity began the self-construction of a new building on January 1, 2017 and the
building was completed on June 30, 2018. The following expenditures were made:
January 1, 2017
April 1, 2017
December 1, 2017
March 1, 2018
4,800,000
6,000,000
3,600,000
7,200,000
Required: Compute for the cost of the building on December 31, 2017 and on June
30, 2018.
1. December 31, 2017
=
14400,000+ 1,080,000=15,480,000
4800*12
=
57600,000
6000*9
=
54,000,000
SB
3600,000*.10=360,000
3600*1
=
3600,000
115,200,000 /12= 9600,000
- 3600,000
=6000,000*.12 =
720,000
1,080,000
2. June 30, 2018
15,480,000*6/6
7200,000*4/6
=
15480,000+7,200,000+1,180,800=23,860,800
=15,4800,000
=
4800,000
20,280,0003600,000=16,680,000*.12=2,001,600*6/12=1000,800
SBC .10 *3600,000*6/12
=
180,000
1180,800
Problem 5.(Adapted C. Valix, J. Peralta, C. Valix 2017 page 1164)Macy
company had the following loans outstanding for the entire year 2017.
Specific construction loan
2,000,000
10%
General Loan
40,000,000
12%
The entity began the self construction of a building on January 1, 2017 and the
building was completed on Dec.31, 2017. The following expenditures were
made during the current year.
January 1
2,000,000
July 1
4,000,000
November 1
6,000,000
Total
12,000,000
Required: Compute the cost the new building.
2000*12 =
24,000,000
4,000*6 =
24,000,000
6000*2 =
12,000,00 =
60,000,000/12=5,000,000
(2000,000)
=3,000,000*.12=360,000+200,
000
= 560,000
+12,000,000
12,560,000
Intangible Assets Answer key
Let’s Check (ULO a&b)
Answer the following adapted problems:
1. An intangible asset is defined as a non monetary asset without physical
substance. (True or False) True
2. All of the following should be capitalized as cost of trademark.
a. Cost of successful litigation of the trademark
b. Registration with Intellectual property code
c. Design cost
d. Legal fee
Answer: False
3. When an entity develops a trademark, the costs directly related to securing it
should generally be capitalized. All of the following costs associated with a
trademark should be capitalized. (True or False)
a. Attorney fees
b. Consulting fees
c. Research and development fees
d. Design costs
4. A trademark is an example of which general category of intangible asset?
Market Related
5. When a patent is amortized, the credit is usually made to the patent account.
True
6. When an entity successfully defended a patent from infringement by a
competitor, the cost of successful litigation should be charged to patent and
amortized over the remaining useful life of the patent. False
7. It refers any creation or product of the human mind or intellect such as an
invention, original design, practical application of a good idea, trademark, literary or
artistic works. Intellectual Proprty
8. When normal earnings exceed future earnings, it is an indication of an
unidentifiable intangible asset. False
9. A franchise is a market based type of intangible whereby there are two parties in
a franchise agreement, the franchisee and the franchisor. (True or False)
10. On January 1, year 1, Leslie Company purchased a patent with a 5,200,000 and
a useful life of 10 years. On December 31, year 2, determined that impairment
indicators were present. The fair value less cost of disposal of the patent was
estimated to be 3,600,000. The value in use is estimated to be 3,800,000. What
amount should be reported as impairment loss for year 1?
Answer:
5,200,000/10=520,000*2=1,040,000-5,200,000=4,160,0003,800,000=360,000IL
11. Young Company purchased for cash at 50 per share all 150,000 ordinary shares
outstanding of another entity. The statement of financial position of the acquiree
on the date of acquisition showed net assets with a carrying amount of 6,000,000.
The fair value of property, plant and equipment on same date was 800,000 in
excess of carrying amount. What amount should be recorded as goodwill on the
date purchase?
Answer: 50*150,000=7,500,000-6,800,000=700,000
12. At year end, Vans Company showed the following account balances:
Patent
500,000
Deposit with advertising agency used to promote goodwill
400,000
Bond sinking fund
1,000,000
Excess of cost over fair value of identifiable net assets of acquired subsidiary
4,000,000
Trademark
900,000
What total amount should be reported as intangible assets? 5,400,000
Let’s Analyze (ULO c)
Answer the following adapted problems:
On January 1, year 1, Suzette Company signed a franchise agreement for a period
of 20 years for an initial fee of 6,000,000.
On the same date, the entity paid 2,000,000 which is not refundable and agreed to
pay the balance in four equal annual payments of 1,000,000 at each year end.
No future services are required are required of the franchisor.
borrow at 14% for a loan of this type.
Present value of 1 at 14% for 4 periods
0.59
Future amount of 1 at 14% for 4 periods
Present value of an ordinary annuity of 1 at 14% for 4 periods
The entity can
1.69
2.91
The agreement further provides that the franchisee shall pay a periodic fee of 5%
based on the annual gross sales. During the current year, Suzette Company
realized gross sales of 25,000,000
Prepare the journal entries for two years in connection with the franchise on the
books of the franchisee.
Required: Determine the initial measurement of the franchise and prepare the
entries for the company for the first two years.
Answer:
Franchise
4,910,000
Initial measurement
Discount on N/P
1,090,000
Cash
Note payable
2,000,000
4,000,000
2.91*1,000,000=2,910,000+2,000,000=4,910,000
2,910,000-4,000,000=1,090,000
Cash 25,000,000
Sales 25,000,000
Franchise fee expense 1,250,000
Cash
1,250,000
Amortization of Franchise 245,500
Franchise
Interest Expense
245,500
407,400
Discount on N/P
407,400
2,910,000*.14=407,400
YEAR 2
Amortization of Franchise 245,500
Franchise
Interest expense
245,500
82,964
Discount on N/P
82,964
2,910,000-407,400=592,600*.14=82,964
Research And Development
Let’s Check (ULO d)
In each item below, put a checkmark if it is a research and development expense.
Equipment acquired for use in various research
__________
Depreciation on the equipment
__________
Materials used
__________
Compensation costs of personnel
__________
Outside consulting fees
__________
Indirect costs appropriately allocated
__________
Modification to the formulation of a chemical product
__________
Trouble-shooting in connection with breakdowns during
Commercial production
__________
Design of tools, jigs, molds and dies involving new technology__________
Seasonal or other periodic design changes to existing products
__________
Laboratory research aimed at discovery of new technology
__________
Let’s Analyze (ULO e)
Answer the following adapted problems:
1. During the current year, Dangerous company incurred the following costs:
Research and development services performed by another
entity for Luminous
300,000
Design, construction and testing of preproduction prototype
And model
400,000
Testing in search for new product or process alternative
350,000
What total amount should be reported as research and development expense in the
current year?
Answer: 1,050,000
2. Milby company incurred the following research and development costs during
the current year:
Equipment purchased for current and future projects
150,000
Equipment purchased for current project only
300,000
Research and development salaries of current project
600,000
Legal fees to obtain patent
75,000
Material and labor costs for prototype product
900,000
The equipment has a five-year useful life and is depreciated using the straight line
method.
What total amount should be recognized as research and development expense for
current year?
Answer: 300,000+900,000 + 600,000 + 150,000/5= 1,830,000
3. Squarepants company made the following expenditures relating to product Y.
Legal costs to file a patent on Product Y. Production of the finished
Product would not have been undertaken without the patent
75,000
Special equipment to be used solely for the development of Product Y
The equipment has no other use and has an estimated useful life of 4 yrs
450,000
Labor and materials costs incurred in producing a prototype
1,500,000
Cost of testing the prototype
600,000
What total amount should be expensed when incurred?
Answer: 450,000+ 1,500,000 + 600,000 =2,550,000
Liabilities 1
Let’s Check
Exercise 1. In each item below, put a checkmark if the item is a liability.
Accounts payable
_____
Advances to employees
Unearned rent revenue
Estimated liability under warranty
Cash surrender value of officer’s life insurance
Bonds payable
Discount on bonds payable
Trade mark
______
______
______
______
______
______
______
Exercise 2.
Accounts payable, after deducting debit balances in supplier’s
Accounts amounting to 100,000
______
Accrued expenses
______
Credit balances of customer’s accounts
______
Share dividends payable
______
Claims for increase in wages and allowance by employees of
the entity covered in a pending lawsuit
______
Estimated expenses in redeeming prize coupons
Presented by customers
______
Let’s Analyze (ULO f)
Answer the following adapted problems:
Problem 1. Miles company revealed the following account balances on Dec. 31,
year 1:
Accounts payable, after deducting debit balances in supplier’s
accounts amounting to 100,000
600,000
Bonds payable, due 2018
1,000,000
Discount on bonds payable
100,000
Dividends payable
150,000
Note payable, due year 3
400,000
What total amount should be reported as current liability?
Answer: 700,000 + 150,000 = 850,000
Problem 2. Milott company disclosed the following liability account balances on
Dec. 31, year 1:
Accounts payable
500,000
Bonds payable
1,000,000
Premium on bonds payable
100,000
Deferred tax liability
300,000
Dividends payable
50,000
Income tax payable
60,000
Notes payable, due January 31, year 3
120,000
The deferred tax liability is based on temporary differences that will reverse in year
2.
On Dec. 31, year 1, what total amount should be reported as current liabilities?
Answer: 500,000 +50,000 + 60,000 = 610,000
Problem 3: The following accounts are taken from the trial balance of Reynaldo
Company for December 31, 2018:
Mortgage payable in quarterly instalments of 100,000
2,000,000
Income tax payable
50,000
Notes payable
750,000
Accounts payable, net of debit balance in supplier’s account of 50,000 300,000
Accrued expenses
60,000
Estimated liability for damages
140,000
Bank loan payable – due June 30, 2020
500,000
How much is the total current liabilities of Reynaldo Company?
a. 1,750,000
b. 1,700,000
c. 1,000,000
d.
1,610,000
Answer: 400,000 + 50,000 + 750,000 + 350,000 + 60,000 + 140,000 =
1,700,000
Problem 4: Caeden company disclosed the following liabilities:
Accounts payable, after deducting debit balances in supplier’s
Accounts amounting to 100,000
800,000
Accrued expenses
300,000
Credit balances in customer’s accounts
100,000
Stock dividends payable
200,000
Claims for increase in wages and allowances by employees
Covered in a pending lawsuit
80,000
Estimated expenses in redeeming prize coupons
120,000
What total amount should be reported as current liabilities?
a. 1,340,000
b. 1,320,000
c. 1,420,000
d. 1,540,000
Answer: 900,000 + 300,000 + 100,000 + 80,000 + 120,000 = 1,420,000
Problem 5: Eric Company provided the following data at year-end:
Accounts payable, including cost of goods goods received
On consignment of 150,000
270,000
Accrued taxes payable
25,000
Customer’s deposit
20,000
Cheche company as guarantor
40,000
Bank overdraft
11,000
Accrued electric and power bills
12,000
Reserve for contingencies
30,000
What total amount should be reported as current liabilities?
a. 368,000
b. 348,000
c. 330,000
d. 308,000
Answer: 120,000 + 25,000 + 20,000 + 11,000 + 12,000 = 188,000
In a Nutshell
Prepare in good form the Liabilities section of the statement of financial position of
Lovegel Company from the following incomplete data provided:
Accounts payable, net of debit balance in supplier’s account, 100,000 900,000
Accounts receivable, net of credit balance in customer’s account, 50,000
600,000
Accrued taxes
50,000
Accrued interest receivable
30,000
Cash on hand and in bank
700,000
Deferred tax liability, reversal period early next year
650,000
Bonds payable, maturing annually of 500,000
2,000,000
Retained earnings
2,700,000
Share capital
1,500,000
Notes payable, due June of next year
800,000
Mortgage payable, 3 years
1,000,000
Other accrued liabilities
200,000
Estimated liabilities
150,000
Prepaid expenses
130,000
Unearned revenue, to be delivered next year
80,000
Lease liability
1,200,000
Patent
250,000
Inventory
700,000
The entity has the discretion to refinance the notes payable due June of next year for
more than 12 months.
The agreement on the mortgage loan has been breached by the entity. However on
December 20 of the current year, the creditor gave a grace period to the entity to
roll over for a period of more than 12 months. The end of the accounting period of
the current year is December 31.
Answer:
Current Liabilities
Accounts payable
Credit balance in A/R
1,000,000
50,000
Accrued taxes
50,000
Bonds payable, maturing annually of 500,000 500,000
Other accrued liabilities
200,000
Estimated liabilities
150,000
Unearned revenue, to be delivered next year 80,000
Total
2,030,000
Non Current liability:
Deferred tax liability, reversal period early next year
650,000
Bonds payable, maturing annually of 500,000
Mortgage payable, 3 years
Lease liability
Notes payable, due June of next year
Total
1,500,000
1,000,000
1,200,000
800,000
5,150,000
Estimated Liabilities
Let’s Check
Problem 1 (Adapted) Erich Company operates a customer loyalty program. During
2019, the entity issued 10,000 award credits and expects that 80% of these award
credits shall be redeemed. The stand alone selling price of the award credits granted
is reliably measured at 200,000
In 2019, the entity sold goods to customers for a total consideration of 1,400,000
based on a stand-alone selling price.
The award credits redeemed and the total award credits expected to be redeemed
each year are as follows:
Redeemed
Expected to be redeemed
2019
3,000
80%
2020
1,590
85%
2021
510
85%
2022
3,000
90%
Required: Compute the amount of revenue from points to be recognized aat each
year end from 2019 until 2022.
Answer:
1,400,000/1,600,000
*1,400,000 =
1,225,000
200,000/1,600,000 *1,400,000 =
175,000
1,600,000
Cash
1,400,000
Sales
1,225,000
Unearned revenue from points 175,000
3000/8000*175,000=65,625
2019 Unearned revenue from points 65,625
Sales
65,625
2020 Unearned revenue from points 28,875
Sales
28,875
4,590/8500 * 175,000
=
94,500 – 65, 625
2021 5,100/8,500 *
175,000
=
=
28,875
105,000- 94,500=10,500
Unearned revenue points 10,500
Sales
10,500
2022 8,100/9,000 * 175,000
=
157,500-105,000=52,500
Unearned revenue form points 52,500
Sales
52,500
Let’s Analyze
Problem 2 (Adapted) In first year, Danaya Company began selling new line of
products that carry a two year warranty against selling defects.
Based upon past experience with other products, the entity estimated warranty
costs as a percentage of peso sales.
First year of warranty
2%
Second year of warranty
5%
First year
Second year
Sales
4,500,000
6,300,000
Actual warranty cost
90,000
270,000
What is the warranty expense for First Year?
Answer: 7% * 4500,000= 315,000
What is the warranty liability on December 31, of first year?
Answer: 315,000- 90,000 =
225,000
What is warranty expense for Second year?
Answer:
7% * 6,300,000 = 441,000
What is the warranty liability on December 31, Second year?
Answer: 225,000 + 441,000 – 270,000
=
396,000
Provide the necessary entries in connection with the warranty of Dumb Company.
Answer:
First Year
Warranty Expense 315,000
Warranty Liability
315,000
Warranty liability
Cash
2nd Year
90,000
90,000
Warranty Expense 441,000
Warranty Liability 441,000
Warranty Liability 270,000
Cash
270,000
In a Nutshell
Problem 3 (Adapted) Uncle Nenens Company includes one coupon in each package
of cereal it sells. A towel is offered as a premium to customers who send in 10
coupons and a cash remittance of 10 pesos. The cost to distribute each towel is 5
each. Data for the premium offer are:
First Year
Second Year
Packages of cereal sold at 30 each
875000
1,400,000
# of towels purchased at 40 per towel 52,500
# of towels distributed as premiums
35,000
105,000
87,500
# of towels to be distributed as premium
Next period
8,750
5,250
The company’s general & administrative expense for year 1 are 10% and 15% of total
sales respectively, while the total distribution and selling expense is 12% and 16% of
total sales respectively. The entity’s interest on loans amounted to 120,000 and the
current year’s tax rate is 30%.
Required: Prepare the Income statement of Uncle Nenens for the 1st year and 2nd
year. In addition, state the amount of estimated liability for premiums to be
presented in the statement of financial position at the end of the 2nd year.
First Year
Second year
Sales 875,000 * 30=
26,250,000
1,400,000 * 30= 420,000,000
Cannot prepare the income statement, no data on cost of sales nor Gross profit
rate…..
Year 1 premium expense is 1,531, 250
35,000+8750=
43,750
* (40-5)
Premium expense 35,000 * 35
Cash 5 ( 35,000)
=
1,531,250
1,225,000
175,000
Premiums 35,000 * 40
1,400,000
Year 1 estimated liability for premiums is 306,250
Premium expense 8,750 * 35 306,250
Estd. Premiums liability
Year 2
306250
Premium expense is 2,940,000
87,500-8,750+ 5,250 = 84,000 * 35 = 2,940,000
Entry assumes there was a reversing entry made previously.
Premium expense
87500 * 35 3,062,500
Cash 87500* 5
437,500
Premiums 87500 * 40
3,500,000
Year 2 estimated liability is 183,750
Premium expense 5,250 * 35 183,750
Premiums liability
183,750
Provision and Contingency
Let’s Check
Fill in the blank: (Adapted)
___________ 1. It is the amount to be recorded where there is a continuous range of
possible outcomes, and each point in that range is likely as any other.
____________ 2. It is the amount that is recognized for a provision.
____________ 3. It is a contract in which the unavoidable costs of meeting the obligation
under the contract exceed the economic benefits to be received under the contract.
____________ 4. This is defined as a “restructured program that is planned and
controlled by the management that materially changes either the scope of a business
of an entity or the manner in which the business is conducted”.
____________ 5. The likelihood that the future event will or will not occur can be
expressed by a range of outcome. Which range means that the future event occurring
is very slight?
___________ 6. It is a possible asset that arise from past event and whose existence
will be confirmed only by the occurrence or non occurrence of one or more uncertain
future events not wholly within the control of the entity.
___________ 7. It is the time when contingent assets are usually recognized.
___________ 8. The correct definition of a provision is a liability which cannot be easily
measured.
___________ 9. All of the following are criteria for recognition of provision: an entity has
a present obligation as a result of a past event; it is probable that an outflow of
resources embodying economic benefits will be required to settle the obligation and
the amount of the obligation can be measured reliably.
___________10. Where there is a continuous range of possible outcomes, and each
point in that range is as likely as any other, the range to used is the Summation of
the minimum and maximum.
___________11. On Dec. 31, year 3 Mild company was a defendant in a pending lawsuit.
The suit arose from the alleged defect of a product that Mild sold in year 2. In the
opinion of Mild’s attorney, it is probable that Mild will have to pay 700,000 as a result,
and it is reasonably possible that Mild will have to pay 800,000 as a result of this
lawsuit. In Mild’s year 3 financial statements, what is the entry to report on this and
any other requisites?
___________ 12. Ximen Company sells electrical goods covered by a one year warranty
for any defects.
Of the sales of 105,000,000 for the year, the entity estimated that 3% will have major
defect, 5% will have minor defect and 92% will have no defect.
The cost of repairs would be 7,500,000 if all the products sold had major defect and
4,500,000 if all had minor defect.
What amount should be recognized as a warranty provision?
13. Irish Company issued the year 1 financial statements on March 1, year 2. The
entity provided the following data for year 1:
Amount owing to another entity for services rendered during
December year 1
1,080,000
Estimated long service leave owing to employees in respect of past
services
4,320,000
Estimated cost of relocating an employee from head office to a branch
In another city (employee will physically relocate January year 2) 360,000
Estimated cost of overhauling machine every 5 years (the machine is 5
years old on December 31, year 1)
540,000
What is the amount of provision at year end?
Answer:
Let’s Analyze
Answer the following adapted problems:
Problem 1 On January 1, year 1, Camella Company purchased a gas detoxification
facility for 5,850,000. The cost of cleaning up the routine contamination ceased by
the initial location of gas on the property is estimated to be 975,000. This cost will
be incurred in 10 years when all of the existing stockpile of gas is detoxified and the
facility is decommissioned. Additional contamination may occur in succeeding
years that the facility is in operation. On January 1, year 3, additional
contamination clean up cost is estimated at 130,000. The appropriate discount rate
is 6%.
The present value of 1 at 6% is 0.63 for 8 periods and 0.56 for 10 periods.
On December 31, year 10, the entity paid a contractor an amount of 1,300,000 for
the decommissioning of the detoxification facility.
Required:
1. Prepared journal entries in year 1 in relation to the detoxification facility and
decommissioning liability.
2. Prepare journal entries in year 3 in relation to the detoxification facility and
decommissioning liability.
3. Prepare journal entries on December 31, year 10 to record the derecognition of
the detoxification facility and the settlement of the decommissioning liability.
Answer:
Year 1
Gas Detox facility 6,396,000
Cash
Decommissioning Liab.
Dec. 31, year 1
5,850,000
975,000* .56546,000
Interest expense
546,000*.06 32,760
Decommissioning Liab.
Depreciation expense
32,760
639,600
Accumulated depreciation 6,396,000/10
639,600
Dec. 31, Year 2
Interest expense 546,000+32,760*.06 34,726
Decommissioning Liab.
34,726
Depreciation exp. 639,600
Accumulated depreciation
639,600
Jan. 1, year 3
Detox facility
130,000*.63 81,900
Decommissioning liability 81,900
Dec. 31, year 3
Interest expense 41,723
546,000+32,760+34,726+81,900
Decommissioning liability 41,723
=
=
Depreciation expense 649,837.50
639,600-639,600
Accumulated depreciation
695,386*.06
41,723
6,396,000+81,900649,837.50
=
649,837.50
In a Nutshell
The problem: (Adapted) Smile Company provided the following information on
December 31, 2017:
1. In May 2017, Smile Company became involved in litigation. In December 2017,
the court assessed a judgement for 800,000 against Smile. The entity is appealing
the amount of the judgement.
The attorneys believed it is probable that the assessment can be reduced on appeal
by 50%. The appeal is expected to take at least a year.
Answer: Loss on lawsuit 800,000
Estd. Liability
800,000
2. A suit was filed on June 2017 for a personal injury amounting to 300,000. Smile
company’s legal counsel concluded that it is not probable that Smile will be
responsible for damages and that 120,000 is the best estimate of the damages.
Answer: no entry
3. In July 2017, Pasig city brought action against Smile company for polluting the
Pasig River with its waste products.
It is probable that Pasig city will be successful but the amount of damages the entity
might have to pay should not exceed 750,000.
Loss on lawsuit 750,000
Estd. Liability
750,000
4. Smile company has signed as guarantor for a 500,000 loan by First bank to
Norhern company, a principal supplier to Smile company. At this time, there is only
a remote likelihood that Smile company will have to make payment on behalf of
Northern company.
Answer: No entry
5. Smile Company has long owned a manufacturing site that has now been
discovered to be contaminated with toxic waste. The entity has acknowledge its
responsibility for contamination.
An initial clean up feasibility study has shown that it will cost at least 250,000 to
clean up the toxic waste.
Answer: 250,000 * PV at discount rate
6. Smile company has been sued for patent infringement and lost the case. A
preliminary judgement of 150,000 was issued and is under appeal. The entity’s
attorneys agree that it is probable that the entity will lose this appeal.
Answer: 150,000
Required: Prepare a summary of journal entries to recognize any provision at the
end of current year.
Be able to explain the transaction which will not require any entry emphasizing the
reason and accounting treatment.
Activity 1
Let’s Check Understanding nature of bonds as to Serial, Term, Debenture or
Secured
Instruction: Identify whether the bonds is a serial bonds, Term bonds,
Debenture or Secured.
1.
2.
3.
4.
5.
6.
7.
8.
9.
Sinking fund bonds, maturing in instalments
3,300,000
Industrial revenue bonds, maturing in installments 2,700,000
Subordinated bonds, maturing at a single date
4,500,000
9% debentures, callable in 2018, due in 2019
7,000,000
11% collateral trust bonds, convertible into share capital
beginning in 2018, due in 2019
6,000,000
10% debentures, 300,000 maturing annually
3,000,000
Bonds maturing in instalments, secured by machinery
500,000
Bonds maturing on a single date, secured by realty
900,000
Collateral trust bonds
1,000,000
Answer:
1. Serial Bonds
Sinking fund bonds, maturing in instalments
3,300,000
Industrial revenue bonds, maturing in installments
2,700,000
10% debentures, 300,000 maturing annually
3,000,000
Bonds maturing in instalments, secured by machinery 500,000
Total
9,500,000
2. Term Bonds
Subordinated bonds, maturing at a single date
9% debentures, callable in 2018, due in 2019
11% collateral trust bonds, convertible into share capital
beginning in 2018, due in 2019
Bonds maturing on a single date, secured by realty
Collateral trust bonds
Total
4,500,000
7,000,000
6,000,000
900,000
1,000,000
19,400,000
3. Debenture bonds
Sinking fund bonds, maturing in instalments
3,300,000
Backed by the
collateral in the fund
Industrial revenue bonds, maturing in installments
2,700,000
Secured by a
letter of credit
11% collateral trust bonds, convertible into share capital
beginning in 2018, due in 2019
6,000,000
Bonds maturing in instalments, secured by machinery
500,000
Bonds maturing on a single date, secured by realty
900,000
Collateral trust bonds
1,000,000
Total
14,400,00
Preparation of amortization table:
10. On January 1, 2017, Lacida company issued 7% long term bonds with face amount of
1,000,000 due January 1, 2025. Interest is payable semiannually on January 1 and July
1. On the date of issue, investors were willing to accept an effective interest of 6%.
Assume the bonds were issued on July 1, 2017 for 1,062,809. Prepare the table of
amortization using the effective interest amortization method and encircle the amount of
recorded interest for the 6 months ended December 31, 2017, in the amount of
_________.
Answer: Table of amortization
Interest Paid Interest Exp. Amortization
Carrying Amount
7/1/17
1,062,809
12/31/17
35,000
31,884
3,116
1,059,693
7/1/18
35,000
31,791
3,209
1,056,484
12/31/18
35,000
31,695
3,305
1,053,179
Let’s Analyze
Answer the following adapted problems:
Problem 1On Jan. 1, 2007, Cobb company issued ten-year bonds with a face amount of
7,500,000 and a stated interest rate of 8% payable annually on Jan. 1. The bonds were priced to
yield 10%. Present value factors are as follows:
Present value of 1 for 10 periods at 10%
0.3855
Present value of an ordinary annuity of 1 for
10 periods at 10%
6.145
Required: Compute for the issue price of the bonds payable and the gain or loss on
extinguishment of the bonds assuming that the bonds is prematurely retired at 98 excluding
accrued interest on April 1, of year 5.
Q1
Compute for the total issue price of the bonds ____________
Answer:
0.3855 * 7,500,000 =
2,891,250
6.145* 7500,000 * .08 =
3,687,000
Total PV
6,578,250
1/1/2007
12/31/2007
12/31/2008
12/31/2009
12/31/2010
4/1/2011
600,000
600,000
600,000
600,000
150,000
657,825
663,608
669,968
676,965
171,165
57,825
63,608
69,968
76,965
21,165
Q2
Prepare the amortization table until 5th year.
Q3
Prepare the entries for 3 years.
1/1/year 1
Cash
6,578,250
Disc. On B/P
921,750
Bonds payable
7,500,000
6,578,250
6,636,075
6,699,683
6,769,651
6,846,616
6,867,781
Interest Expense.
Cash.
(7,500,000- 6,578,250)
12/31/year 1
Interest expense
657,825
Cash
600,000
Disc. On B/P
57,825
600,000
600,000
Interest Expense 57,825
Disc. on BP.
57,825
12/31/year 2
Interest expense
663,608
Cash
600,000
Disc. On B/P
63,608
12/31/year 3
Interest expense
669,968
Cash
600,000
Disc. On N/P
69,968
Year 5 upon premature retirement on April 1
Update amortization
Interest expense
21,165
Disc. On B/P
21,165
B/P
7,500,000
Interest expense
150,000
Loss on retirement
482,219
Cash
Disc. On B/P
7,500,000
632,219
7500,000*.98+150,000=7,500,000
Accrued interest 7,500000*.08*3/12 =150,000
7,350,000-6,867,781
=
482,219
Problem 2. On Jan. 1, 2007, Manila company issued 5-year bonds with face value of 4,000,000
at 110.
The company paid bond issue cost of 64,000 on same date. The stated interest rate on bonds is
8% payable annually every Dec. 31. The bonds are issued to yield 6% per annum.
Manila company uses the effective interest method of amortization.
Required:
a. Prepare the table of amortization
4,000,000*1.10=4,400,000-64,000=4,336,000
Answer:
1/1/2007
4,336,000
12/31 320,000
260,160
59,840
4,276,160
12/31 320,000
256,570
63,430
4,212,730
12/31 320,000
252,764
67,236
4,145,494
12/31 320,000
248,730
71,270
4,074,224
12/31 320,000
245,776
74,224
4,000,000
b. Prepare the journal entries from issuance until the end of 3rd year.
Answer:
1/1/2007
Cash 4,336,000
Bonds payable
4,000,000
Premium on B/P
336,000
12/31/year 1 Interest expense
Premium on B/P
Cash
260,160
59,840
320,000
12/31/year 2 Interest expense
Premium on B/P
Cash
256,570
63,430
320,000
12/31/year
252,764
67,236
320,000
Interest expense
Premium on B/P
Cash
c. Answer the following questions:
Q1. How much is the cash received upon issuance?
4,336,000
Q2. What is the carrying amount of the bonds at the end of 2nd year? 4,212,730
Q3. How much is the interest expense to be reported in the Income statement for the 3 rd year?
252,764
Problem 3: On December 31, 2019, Famous Company sold a 12% serial bond issue with face
amount of 5,600,000 for 5,936,000.
The bonds mature in the amount of 800,000 on December 31 of each year beginning December
31, 2020 and interest is payable annually.
On December 31, 2021, the entity retired 800,000 of bonds due on that date and in addition
purchased at 105 and retired bonds with face amount of 800,000 which were due on December
31, 2023.
Required:
a. Prepare the original table of amortization.
Answer:
12/31/2019
12/31/2020
5,600,000
84,000
12/31/2021
4,800,000
72,000
12/31/2022
4,000,000
60,000
12/31/2023
3,200,000
48,000
12/31/2024
2,400,000
36,000
12/31/2025
1,600,000
24,000
12/31/2026
800,000
12,000
22,400,000
336,000
b. Prepare the revised table of amortization
336,000/22400,000= .015 * 800,000=12,000 * 2= 24,000
12/31/2019
12/31/2020
12/31/2021
12/31/2022
12/31/2023
12/31/2024
12/31/2025
12/31/2026
5,600,000
4,800,000
4,000,000
3,200,000
2,400,000
1,600,000
800,000
22,400,000
60,000 – 12,000
48,000 – 12,000
36,000
24,000
12,000
336,000
c. Prepare the entries until the end of year 4.
Answer:
Cash
5,936,000
Bonds payable
5,600,000
Premium on B/P
336,000
12/31/2020
Interest expense 5,600,000*.12 672,000
Cash
672,000
Premium on B/P
84,000
Interest expense
B/P
84,000
800,000
Cash
800,000
12/31/2021
Interest expense
4,800,000 * .12 576,000
Cash
576,000
Premium on B/P
72,000
Interest expense
B/P
800,000
Cash
800,000
For the prematurely retired:
72,000
=
=
84,000
72,000
48,000
36,000
36,000
24,000
12,000
B/P
800,000
Premium on B/P
24,000
Loss on retirement
16,000
Cash
800,000 *1.05 840,000
840,000-824,000=
16,000
In a Nutshell
Problem 1 (Adapted) On January 1, 2019, Rustom Company received 4,308,000 for a 4,000,000
face amount 12% bonds, a price that yields 10%. The bonds pay interest semiannually on June
30 and December 31.
The entity elected the fair value option. On December 31, 2019, the fair value of the bond is
determine to be 4,100,000 based on market and interest factors.
Q1
What is the amount of interest expense to be reported for 2019?
Answer
Interest expense
480,000
Q2
What is the gain or loss that should be recognized in 2019 to report the bond at fair value?
4,308,000-4,100,000=208,000
B/P
208,000
Gain from change in FV
208,000
Q3
What is the carrying amount of the bonds payable on December 31, 2019? 4,100,000
Q4
Prepare Journal entries
Answer:
Cash 4,308,000
B/P
4,308,000
Interest expense
Cash
240,000
240,000
Interest expense
Cash
240,000
240,000
B/P
208,000
Gain from change in FV
208,000
Q5
Had the company elected the “Amortized Cost” of recording bonds, what will be
your answers to Q1 to Q4.
4,308,000*.10*6/12= 215,400 – 240,000= 24,600- 4308,000=
4283,400*.10*6/12= 214,170 – 240,000=25,830
429,570
interest expense
Q2
Q3
Q4
=
zero
= 4,283,400- 25,830= 4,257,570
Cash
4,308,000
B/P
4,000,000
Premium on B/P 308,000
Interest expense
215,400
Premium on B/P
24,600
Cash
240,000
Interest expense
214,170
Premium on B/P
25,830
Cash
240,000
Let’s Check
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
When the cash proceeds from bonds issued with share warrants exceed the fair value of the
bonds without the warrants, the excess should be credited to ____SWO___________.
Cash proceeds from the issuance of convertible bonds payable should be reported as liability for
the entire proceeds. (True or False)
When bonds are issued with share warrants, the liability component is equal to the excess of the
proceeds over the fair value of the bonds without the share warrants. (True or False)
The proceeds from an issue of bonds with share warrants should not be allocated between the
liability and equity component. (True or False)
A bond convertible into a fixed number of ordinary shares of the entity is a compound financial
instrument. True
Convertible bonds, after issuance must at all times be exchanged for equity shares. (True or
False)
The entry to record retirement of convertible bonds at maturity will recognize either gain or loss
on retirement of bonds payable. (True or False)
In the allocation of the issue price between the liability component and equity component, the
first priority basis for allocating the price is to give liability component equal to the present value
of principal and interest payments. (True or False)
The issuer of the bonds payable with warrants shall classify the liability and equity component
separately. (True or False)
The residual amount of the issue price is allocated to the warrants, meaning liability component
is allocated a value first. (True or False)
Let’s Analyze
Answer the following adapted problems:
Problem 1 Umbrella Corporation has 4,000, 10%, 10-year bonds, face value 1,000, and sold it at
105. Each bond is accompanied by one warrant that permits the bondholder to purchase 20
shares of capital, par 50, at 55 per share, or a total of 80,000 shares. The prevailing market rate
of interest for similar bonds without warrants is 12% per annum with which the PV of 1 at 12% for
10 periods is .322 and in an ordinary annuity is 5.65.
What is the entry to record issuance of the compound instrument and the exercise of the 70%
warrants? Assume also the expiration of the 30% warrants and prepare the entry.
Answer:
4,000(1,000)= 4,000,000 *1.05
= 4200,000
4,000,000*.322=
1,288,000
4,000,000*.10*5.65= 2,260,000
=3,548,000
652,000
Cash
4,200,000
Discount on B/P
452,000
B/P
4,000,000
SWO
652,000
Cash 4,000(20)*.70*55
3,080,000
SWO 652,000 *.70
456,400
Share capital 4000(20)*.70*50
2,800,000
Share premium
SWO .30*652,000
Share premium
736,400
195,600
195,600
Problem 2 At the beginning of the current year, Claudine Corporation issued 6,000, 5-year bonds,
face value 1,000 each at 105. The bonds has a conversion privilege that provides for an exchange
of a 1,000 bond for 20 shares of capital, par 50. Without such conversion privilege, the bonds
would only sell at 98.
Prepare the entries in connection with the issuance of the bonds and the conversion of the bonds
at the end of the current year.
Answer:
6,000(1,000) *1.05
=
6,300,000
6,000(1000)*.98
=
5,880,000
SP- conversion privilege
420,000
Cash
Discount on B/P
B/P
SP – CP
6,300,000
120,000
6,000,000
420,000
120,000/5=24,000
Interest expense
Cash
Interest Expense
24,000
Discount on B/P
24,000
B/P
6,000,000
SP – CP
420,000
Discount on B/P
96,000
Share premium-OS 324,000
Share capital
6,000,000
6000*20*50=6M
Problem 3 Faith Company issued 5500 convertible bonds on January 1, 2019. The bonds have
a three year term and are issued at 110 with a face value of 1,000 per bond. Interest is payable
annually in arrears at a nominal 6% interest rate. Each bond is convertible at any time up to
maturity into 100 common shares with par value of 5. When the bonds are issued, the prevailing
market interest rate for similar debt instrument without conversion option is 9%. The present
value of 1 at 9% for 3 periods is .77 and the present value of an ordinary annuity of 1 at 9% for 3
periods is 2.53.
Case a. Prepare the entries of the company in connection with the bonds for its 3 year term
assuming the bonds were not converted.
Answer:
5,500(1000)*110
=
6,050,000
5500,000*.77
=
4,235,000
5500,000*.06*2.53
=
834,900
SP – CP
5,069,900
980,100
Cash
6,050,000
Discount on B/P
430,100
B/P
5,500,000
SP-CP
980,100
12/31/2019
Interest expense
5500,000(.06)
330,000
Cash
Interest expense
330,000
126,291
Discount on B/P
126,291
5,069,900*.09=456291-330,000=126,291
12/31/year 2020
Interest expense
330,000
Cash
330,000
Interest expense
137,657
Discount on B/P
137,657
5,069,900+126,291=5,196,191*.09=467,657-330,000=137,657
12/31/year 2021
Interest expense
330,000
Cash
Interest expense
330,000
166,152
Discount on B/P
166,152
5,196,191+137,657-5,500,000=166,152
B/P
5,500,000
Cash
5,500,000
Case b. Suppose that the company converted the bonds on December 31, 2019, Prepare the
entries on the bonds during 2019.
B/P
5,500,000
SP-CP
980,100
Discount on B/P
303,809
Share capital
2,750,000
Share premium
3,426,291
5500*100*5=2,750,000
Let’s Check
1. Under a debt restructuring involving substantial modification of terms, the future cash flows
under the new terms shall be discounted using (a. Market rate of interest b. Original effective
interest rate)
2. There is substantial modification of terms of an old financial liability if the gain or loss on
extinguishment is (a. At least 10% of the carrying amount of the old liability b. At least 10% of
the carrying amount of the new liability)
3. The accounting issue on extinguishment of a financial liability by issuing equity instruments is now
well settled under IFRIC 19. (TrueorFalse)
4. An
asset
swap
is
the
issuanceofsharecapitalbythedebtortothecreditor
in
fullprpartialpaymentofanobligation. (TrueorFalse)
5. Under PFRS 9, asset swap isrecorded as iftwotransactionshavetakenplace; sale
oftheassetandextinguishmentofliability. (TrueorFalse)
6. The differencebetweenthecarryingamountoftheliabilityandthefairvalueoftheassetis gain orloss
from restructuring. (TrueorFalse)
7. Maturity value concession involves a reduction of interest rate, forgiveness of unpaid interest or
moratorium oninterest. (TrueorFalse)
8. Under USA GAAP, the gain or loss on debt restructuring is the difference between the carrying
amount of the old liability and the present value of the new restructured liability. (TrueorFalse)
9. When the gain on extinguishment of liability is less than 10% of the carrying amount of the old
financial liability, theamount should be recognized. (TrueorFalse)
10. USA GAAP shall be followed in accounting for debt restructuring conceived as modification of
terms. (TrueorFalse)
Let’s Analyze :
Answer the following adapted problems:
1. During 2019, Shyrill company experienced financial difficulties and is likely to default on a
9,000,000, 15% three year note dated Jan. 1, 2017, Payable to Canque Bank. On Dec. 31,
2019, the bank agreed to settle the note and unpaid interest of 1,350,000 for 2019 for
7,380,000 cash payable on Jan. 31, 2020. The amount that Shyrill company report as gain
from extinguishment of debt in its 2019 income statement is ________________ and the entry
in connection with the settlement is____________________.
Answer: N/P
9,000,000
I/P
1,350,000
Cash
7,380,000
Gain
2,970,000
2. Sunset Company showed the following data with respect to a matured obligation:
Mortgage payable
Accrued interest payable
6,400,000
480,000
The entity is threatened with a court suit if it could not pay its maturing debt. Accordingly, the
entity entered into an agreement with the creditor for the issuance of share capital in full settlement
of the mortgage.
The agreement provided for the issue of 35,000 shares with par value of 80. The share is currently
quoted at 104. The fair value of the liability is 3,600,000.
Required: Prepare the journal entry to record the equity swap on the books of Sunset Company.
Answer:
M/P 6,400,000
AIP
480,000
Share capital 35,000 *80
2,800,000
Gain
3,240,000
Share premium
840,000
35,000 * 104 =
3,640,000 – 6,880,000=3,240,000
3,640,000-2,800,000=840,000
3. Seal company is experiencing financial difficulty and is negotiating debt restructuring with
its creditor to relieve its financial stress. Seal has a 2,000,000 note payable to United
Bank. The bank is considering acceptance of an equity interest in Seal company in the
form of 200,000 ordinary shares fairly valued at 9.6 per share. The par value is 8 per
share. How much share premium should be recognized from the debt restructuring?
Answer: N/P
2,000,000
Share capital
1,600,000
Gain
80,000
Share premium
320,000
9.6 (200,000)
=1,920,000 – 2,000,000=80,000
1920,000-1,600,000= 320,000
4. Land costing 480,000 and building costing 3,520,000 with accumulated depreciation of
960,000, were mortgaged to secure a bank loan of 2,400,000. Data regarding the loan are:
Face of the loan
Accrued interest
Legal fee and bank service charges
Total
2,400,000
240,000
40,000
2,680,000
Subsequently, the land and building were given in full settlement of the liability.
Required: Prepare the entry of this Dacion en Pago transaction.
L/P
2,400,000
AIP
240,000
BSC
40,000
Acc. Dep’n
960,000
Loss
360,000
Land
480,000
Building
3,520,000
5. An entity shows the following balances on December 31, 2010:
Note payable
3,200,000
Accrued interest
640,000
Total liability
3,840,000
On December 31, 2010, the entity transfers to the creditor land recorded at cost of 2,400,000 with
fair value of 3,520,000.
Required: Prepare the entry to record the asset swap under PAS 39 and US GAAP.
PAS 39
USA GAAP
N/P
3,200,000
N/P
3,200,000
AIP
640,000
AIP
640,000
Land
2,400,000
Land
2,400,000
Gain
1,440,000
Gain on exchange 1,120,000
Gain on DR
320,000
In a Nutshell
Problem 1(Adapted) Green Company has an overdue 8% note payable to City Bank at
6,400,000 and recorded accrued interest of 512,000. As a result of a settlement on January 1,
2017, City Bank agreed to the following restructuring arrangement:
a.
b.
c.
d.
Reduced the principal obligation to 5,600,000.
Forgave the 512,000 accrued interest.
Extended the maturity date to December 31, 2018.
Annual interest of 10% is to be paid on December 31, 2017 and 2018.
The present value of 1 at 8% for two periods is 0.8573, and the present value of an ordinary
annuity of 1 at 8% for two periods is 1.7833.
Required:
Prepare the entries for 2017 and 2018 to record the modification of
termsandshowallthenecessarysolutions.
Answer:
N/P
6,400,000
AIP
512,000
N/P
5,600,000
Gain on extinguishment
1,112,472
Premium on N/P
199,528
5,600,000 (.8573)
=
4,800,880
5,600,000*.10*1.7833=
998,648
Total
5,799,528
-
5,600,000 = 199,528 premium
6912000-5799528=1112,472/6912000=16%
12/31/2017
Interest expense
Cash
560,000
560,000
Premium on N/P
96,038
Interest expense
96,038
Amortization table
5,799,528
560,000
463,962
96,038
5,703,490
560,000
456,510
103,490
5600,000
Problem 2 (Adapted)
maturedobligation:
Sandara
Company
Mortgagepayable
Accruedinterestpayable
showedthefollowing
data
withrespectto
a
3,200,000
240,000
The entityenteredintoanagreementwiththecreditorsfortheissuanceofcapital in
fullsettlementofthemortgage.
The agreementprovidedfortheissueof 35,000 shareswith par valueof 80. The sharesiscurrentlyquotedat
104. The fairvalueoftheliabilityis 3,600,000.
Required: Preparejournalentry o recordtheequity swap onthebooksof Sandara Company:
1. If thefairvalueofthesharecapitalisusedfortheequity swap.
2. If thefairvalueoftheliabilityisusedfortheequity swap.
3. If thecarryingamountoftheliabilityisusedfortheequiy swap.
1.
Answer:
M/P 3,200,000
AIP
240,000
Loss 200,000
Share capital 35,000 *80
Share premium
35,000 * 104 =
3,640,000 – 3,440,000=200,000
3,640,000-2,800,000=840,000
2.
M/P
AIP
Loss
3,200,000
240,000
160,000
Share Capital 2,800,000
Share premium 800,000
3,600,000-3440,000= 160,000 Loss
3,600,000-2800,000=800,000
3.
M/P
AIP
3,200,000
240,000
2,800,000
840,000
Loss
Share capital
Share premium
2,800,000
640,000
Let’s Check
1.
The fair value option of recording note payable, amortizes discount at every end of
the year. (True or False)
2. The cost of asset acquired upon the issuance of a noninterest bearing note is equal
to the cash equivalent price, if readily available. (True or False)
3. The cost of the asset acquired by an issuance of a noninterest bearing note does not
include the down payment made on the date of transaction. (True or False)
4. The difference between the cash equivalent price of 540,000 for an equipment
acquired at 600,000 noninterest bearing note is a loss on acquisition of the asset.
(True or False)
5. When a company’s own note is discounted at the bank, the difference between the
face value of the note and the cash proceeds from the bank is amortized as interest
expense over the period of the note. (True or False)
6. When an entity issued a note solely in exchange for cash, the present value of the
note at issuance is equal to its face value. (True or False)
7. If the present value of a note issued in exchanged for a property is less than the face
amount, the difference should be included in the cost of the asset. (True or False)
8. Discount on note payable may be debited when an entity discounts its own note with
the bank. (True or False)
9. The discount on note payable is a deduction from the face amount of note payable.
(True or False)
10. The discount on note payable represents interest charges applicable to past periods.
(True or False)
11. Amortizing the discount on note payable gradually decreases the carrying amount of
the liability over the life of the note. (True or False)
12. The discount resulting from the determination of the present value of a note payable
should be reported as
a. Deferred credit
b. Direct deduction from the face amount of the note
c. Deferred charge
d. Addition to the face of the note
13. When a note payable is exchanged for property, the stated interest rate is presumed
to be fair when
a. No interest rate is stated
b. The stated interest rate is unreasonable
c. The face amount of the note is materially different from the cash sale price for
similar property
d. The stated interest rate is equal to the market rate
14. On October 1, 2019, an entity borrowed cash and signed a three year interest bearing
note on which both principal and interest are payable on Oct. 1,2022. On Dec. 31,
2021 accrued interest payable should
a. Be reported as current liability
b. Be reported as noncurrent liability
c. Be reported as part of noncurrent note payable
d. Not be reported as liability
Let’s Analyze
Answer the following adapted problems:
1. Assume that on January 1, 2011, an entity acquired an equipment with a cash price of
400,000 for 550,000, 150,000 down and the balance payable in 4 equal annual
instalments. What is the amount to be debited as cost of the Equipment?
Answer: The cost of the asset is the cash equivalent price of 400,000
2. On January 1, 2019, Mabelle Company acquired a tract of land for 10,500,000. The entity
paid a 2,500,000 down payment and signed a non interest bearing note for the balance
which is due on January 1, 2022.
There was no established exchange price for the land and the note had no ready market.
The prevailing interest rate for this type of note was 12%. The present value of 1 at 12%
for 3 periods is .7118.
Q1
What is the cost of the land?
DP
=
2500,000
PV of N/P
= .7118(8000,000)
5,694,400
8,194,400
Q2
What is the initial carrying amount of the notes payable?
Note payable
8,000,000
Discount on N/P
2,305,600
CA
5,694,400
Q3
What is the amount of interest expense for the year 2019?
Interest Expense 2019
5,694,400(.12)=
683,328
Q4
What is the carrying amount of the notes payable on Dec. 31, 2019?
Note payable
8,000,000
Discount on N/P
(1,622,272)
(2,305,600-683,328)
CA 12/31/2019
6,377,728
3.
On March 2, 2018, Firefly company borrowed 800,000 and signed a 2-year note bearing
interest at 12% per annum compounded annually. Interest is payable in full at maturity
on Feb. 28,2020.
Q1
What is the amount of interest expense for Dec. 2018?
800,000*.12*10/12=80,000
Q2
What is the amount of interest expense for Dec. 2019?
880,000*.12=105,600
In a Nutshell
Answer the following adapted problems:
Problem 1.
On January 1, 2019,Joanna Company borrowed 1,000,000 8% noninterest bearing note
due in four years. The present value of the note on the date of issuance was 367,500. The entity
elected irrevocable the fair value option in measuring the note payable. On December 31, 2019, the fair
value of the note is 408,150.
Q1
What is the carrying amount of the note payable on December 31, 2019?
At FV 408,150
Q2
What amount should be reported as interest expense for 2019?
1,000,000 (.08) =
80,000
Q3
What amount of gain from change in fair value of the note payable should be reported for
2019? 367,500-408,150=40,650
Answer is Zero because its not gain.
Loss from change in FV 40,650
N/P
Q4
Zero
40,650
At what amount should the discount on note payable be presented on December 31, 2019?
Problem 2On January 1, 2011 an entity acquired an equipment for 2,000,000 payable in 5 equal
annual instalments on every December 31, of each year. The prevailing market interest rate is
10%. The table of present value shows that the present value factor of an annuity of 1 for 5 years
at 10% is 3.7908. Prepare the entries for 2011 and 2012 and show the necessary solutions.
Answer:
1/1/2011
Equipment
1,516,320
Discount on N/P
483,680
Note payable
2,000,000
= 3.7908 (400,000)=1,516,320
12/31/2011
Notes payable 400,000
Cash
400,000
Interest expense ( 1,516,320*.10)
Discount on N/P
12/31/2012
Notes payable 400,000
Cash
400,000
Interest expense 1,267,952*.10
Discount on note payable
400,000
400,000
151,632
151,632
151,632
126,795
126,952
248368
273,205
126,795
1516320
1,267,952
994,747
Problem 3On January 1, 2011, an entity acquired an equipment for 3,000,000. The entity paid
300,000 down and signed a noninterest bearing note for the balance which is due after three
years on January 1, 2014. The prevailing interest rate is 10%. The present value of 1 for 3
periods is .7513.
Required 1
Prepare the entries for 2011 and 2012.
1/1/2011
Equipment
2,328,510
Discount on N/P
671,490
Cash
300,000
Note payable 2,700,000
.7513(2,700,000)=2,028,510 + 300,000=2,328,510
2,700,000-2,028,510 = 671,490
12/31/2011
Interest expense
202,851
Discount on N/P
202,851
12/31/2012
Interest Expense
223,136
Discount on N/P
223,136
Required 2
Prepare the amortization table.
12/31/2011
12/31/2012
12/31/2013
202,851
223,136
245,503
2,028,510
2,231,361
2454,497
2,700,000
Let’s Check
____________ 1. It is defined as an agreement whereby the lessor conveys to the lessee in
return for a payment or series of payments the right to use an asset for an agreed period of time.
LEASE
____________ 2. and ___________ 3. What are the two types of leases? OPERATING AND
FINANCE LEASE
____________ 4. It is the type of lease whereby periodic rental is simply recognized as rent
expense on the part of the lessee and also called the rental approach. OPERATING LEASE
____________ 5. It is an amount paid by the lessee to the lessor in addition to periodic rental
and amortized as rent expense over the lease term. LEASE BONUS
____________ 6. It is often incurred by the lessor and includes amounts such as commissions,
legal fees and internal costs that are incremental and directly attributable to negotiating and
arranging the lease. Initial Direct Cost
____________ 7. It is refundable upon the lease expiration and accounted for as a liability by the
lessor. Security Deposit
____________ 8. These refers to ownership costs and expenses usually born by the lessor such
as depreciation of leased property, real property taxes, insurance and maintenance. Ownership
costs
____________ 9. What PAS covers the accounting for operating lease? PAS 17
____________ 10. The balance of the deferred initial direct cost shall be presented as an addition
to the carrying amount of machinery. (True or False) True
Let’s Analyze
Answer the following Adapted Problems:
Problem 1. On Oct. 1, 2017, Dean company leased office space at a monthly rental of 600,000
for 10 years expiring Sept. 30,2027. As an inducement for Dean to enter into the lease, the lessor
permitted Dean to occupy the premises rent free from Oct. 1 to Dec. 31, 2017. For the year ended
Dec. 31, 2017, Dean should record rent expense amounting to _______________.
Answer: 600,000*12= 72,000,000 – (600,000*3)= 70,200,000/10=7,020,000*3/12=1,755,000
Problem 2. Ramzel company leased a new machine to Marlon company on Jan. 1, 2017. The
lease expires on Jan. 1, 2022. The annual rental is 900,000. Additionally, on Jan. 1, 2017, Marlon
paid 500,000 to Ramzel as a lease bonus and 250,000 as a security deposit to be refunded upon
expiration of the lease. In Ramzel’s 2017 income statement, the amount of rental revenue should
be ______________.
Answer:
900,000 + (500,000/5)= 1000,000
Problem 3 Rod Company purchased a tractor on Jan 1,2017 at a cost of P1,600,000 for the
purpose of leasing it. The tractor is estimated to have a useful life of 5 years with residual value
of P100,000. Depreciation is on a straight line basis. On April 1,2017, Rod entered into a lease
contract for the lease of the tractor for a term of two years up to March 31,2019. The lease fee is
P50,000 monthly and the lessee paid P600,000, the lease fee for one year. Rod paid P120,000
commission associated with negotiating the lease, P15,000 minor repairs, and P10,000
transportation of the tractor to the lessee during 2017. Rod Company should report net rent
revenue for the year 2017 at _____________.
Answer: 600,000 *9/12=450,000-(120,000/2*9/12)-15,000-10,000=380,000- 300,000=80,000
Problem 4. Roche Company, lessor, leases its equipment under an operating lease. The lease term
is for 5 years and the lease payments are made in advance on January 1 of each year as shown
in the following schedule:
January 1, 2017
800,000
January 1, 2018
800,000
January 1, 2019
1,120,000
January 1, 2020
1,360,000
January 1, 2021
1,520,000
On December 31, 2018, what amount should be reported as rent receivable? And what is the entry
on December 31, 2019?
Answer:
Question
800,000+800,000+1,120,000+1,360,000+1520,000=5,600,000/5=1,120,000*2=2,240,000800,000-800,000=640,000
1:
Question 2: Cash 1,120,000
Rent Income 1,120,000
Problem 5 On May 1, 2019, Huggies company leased equipment to Raven company which expires
on May 1, 2020. Raven could have bought the equipment from Huggies for 4,160,000 instead of
leasing it.
Huggies accounting records showed a carrying amount for the equipment on May 1, 2019 for
3,640,000. Huggies depreciation on the equipment in 2019 was 468,000.
During 2019, Raven paid 936,000 in rentals to Huggies for the 8-month period. Huggise incurred
maintenance and other related costs under the terms of the lease of 83,200 in 2019.
After the lease with Raven expires, Huggies will lease the equipment to another entity for two years.
What is the pretax income derived by Huggies for 2019?
Answer: 936,000-83,200-468,000=384,800
In a Nutshell
The explorer company hired you as part time employee in their accounting office. One
transaction you encountered in the office is the recording in connection with the following
lease agreement:
Explorer company purchased a machine on January 1, 2019 for 3,000,000 for the
purpose of leasing it.
The machine was expected to have a 10-year life with no residual value and the straight
line method of depreciation is used.
On March 1, 2019, Explorer company leased the machine to Anne company for 720,000
a year for 4 years ending Feb. 28, 2023.
Explorer company paid a total of 36,000 for maintenance and received 720,000 from
Anne company on March 1, 2019.
Explorer company retains title to the property and plans to lease it to someone else after
the 4 year lease period.
Required:
1. Prepare journal entries on the books of Explorer company.
2. Determine the net rent income of Explorer company
Answer: 1
January 1
Machinery 3,000,000
Cash
March 1
Cash
3,000,000
720,000
Rent Income
720,000
Repairs and maintenance expense
Cash
December 31
36,000
36,000
Depreciation expense 300,000
Accumulated depreciation
3,000,000/10
Rent Income
120,000
Unearned rent 120,000
720,000 * 2/12
300,000
Question 2: Net Rent Income
600,000-36,000-300,000=264000
Direct Financing Lease
Let’s Check
1.
Gross investment in the lease is equal to the present value of the lease payments under
a finance lease of the lessor. (True or False)
2. Net investment in a direct financing lease is equal to the cost of the asset plus initial direct
cost paid by the lessor. (True or False)
3. The primary difference between a direct financing lease and a sales type lease is the
recognition of the manufacturer or dealer profit at the inception of the lease for a direct
financing lease type. (True or False)
4. Lessor shall recognize asset held under a finance lease as a receivable at an amount
equal to the net investment in the lease. (True or False)
5. The difference between gross investment and net investment in the lease under a direct
financing lease is amortized through interest expense over the period of the lease. (True
or False)
6. The amortization of unearned interest income increases interest income reported in the
statement of profit or loss for the period. (True or False)
7. At the date of expiration of the lease, when the residual value is equal to the fair value of
the asset under lease, upon the return of the asset to the lessor, the entry on the books
of the lessor is the same whether the residual value is guaranteed or unguaranteed. (True
or False)
8. The lessor records loss on finance lease when the residual value is guaranteed and the
fair value on the date of expiration is lower than the guaranteed residual value. (True or
False)
9. Initial direct cost is added to the cost of the asset under lease to determine the net
investment in the lease. (True or False)
10. Computation of a new implicit rate is not required when there is initial direct cost paid for
by the lessor because it is ignored. (True or False)
Let’s Analyze
Answer the following adapted problems:
Problem 1
Danaya Company is in the business of leasing new sophisticated equipment. The lessor
expects a 12% returnon net investment.
All leases are classified as directfinancinglease.
At the end of the lease term, the equipment will revert to the lessor.
On January 1, 2019, an equipment is leased to a lessee with the following information:
Cost of equipment to the lessor
4,000,000
Residual vaule – unguaranteed
480,000
Annual rental payable in advance
720,000
Initial direct cost incurred by the lessor
200,000
Useful life and lease term
8 years
Implicit interest rate
12%
First lease payment
January 1, 2019
Q1
What is the gross investment in the lease?
GI=GR + RV
= ( 720,000* 8 ) + 480,000
= 6,240,000
Q2
What is the net investment in the lease?
NI= Cost of the asset Plus Initial direct cost
= 4,000,000 Plus 200,000
= 4,200,000
Q3
What is the total interest income over the lease term?
Total Interest Income = GI less NI
= 6,240,000 – 4,200,000
= 2,040,000
Q4
What is the interest income for 2019?
Interest Income 2019 =
4,200,000*.12=504,000
Problem 2
On January 1, 2019, Kyle company entered into a direct financing lease. A third party
guaranteed the residual value of the asset under the lease estimated to be 1,800,000 On
January 1, 2024, the end of the lease term.
Annual lease payments are 1,500,000 due each December 31, beginning December 31,
2019. The last payment is due December 31, 2023.
The remaining useful life of the asset was six years at the commencement of the lease.
The lessor used 10% as the implicit interest rate. The present value of 1 at 10% for 5
periods is .62 and the PV of an ordinary annuity of 1 at 10% for 5 periodsis 3.79.
Answer
Q1
What is the net lease receivable of the lessor at the commencement of the lease?
Gross Lease Receivables
9,300,000
PV .62*1800000+3.79*1500,000=
6,801000 Net Lease receivable
Less: UII
2,499,000
Q2
What is the gross investment in the lease?
GI= 5 (1500000)=7500,000+1800000
= 9,300,000
Q3
What is the total unearned interest income? 2,499,000
Q4
What is the interest income for 2019? 6,801,000*.10=680,100
Problem 3
Glydelle Company lease a computer equipment under a direct financing lease. The
equipment has no residual value at the end of the lease and the lease does not contain
purchase option.
The entity wishes to earn 8% interest on a 5-year lease of equipment with a cost of
6,468,000.
The present value of an annuity due of 1 at 8% for 5 years is 4.312.
What total amount of interest revenue should be recognized over the lease term?
6,468,000/4.312=1500,000
1500,000*5=7,500,000 Total lease receivables
Less Cost
6,468,000
UII
1,032,000
Problem 4
Erich Company leased an asset to another entity. The cost of the asset was 4,796,400.
Terms of the lease specify four year life for the lease, an annual interest rate of 15%, and
four year-end rental payments. The lease qualified as a direct financing lease.
The lease provided for a transfer of title to the lessee at the end of the lease term.
After the fourth year, the residual value was estimated at 600,000.
The PV of 1 at 15% for 4 periods is .572, and the PV of an ordinary annuityof 1 at 15%
for 4 periods is 2.855.
What is the annual rental payment?
Answer: 4,796,400/2.855
=
1,680,000
Problem 5
At the beginning of a current year, Yvonne company signed a ten-year non cancelable
lease agreement to lease a storage building from Ware company. The agreement
required equal rental payments at the end of each year.
The fair value of the building at the inception of the lease is 2,654,640. However the
carrying amount to Ware company is 2, 212,200. The building has an estimated
economic life of 10 years with no residual value.
At the termination of the lease, the title to the building will be transferred to Yvonne
Company. The incremental borrowing rate of Yvonne company is 12% per year.
Ware company set the annual rental to insure a 10% rate of return. The implicit rate of
the lessor is known by the lessee.
The annual total lease payment included 18,000 of executory costs related to taxes on
the property. Round off present value factor to three decimal places.
Q1
What is the annual lease payment?
Answer: 2,654,640/6.145= 432,000
Q2
What is the total annual lease payment?
Answer: 432,000 Plus 18,000=450,000
Q3
What is the unearned interest income of the lessor at the beginning of current
year?
Gross Investment 432,000*10=
4,320,000
Net investment equal to fair values
2,654,640
UII
1,665,360
In a Nutshell
Problem 1 (Adapted)
Herminio Company is engaged in leasing of equipment. All of its
leases are classified as a direct financing one. As lessor, the company exepcts a 12% return on
its investment. At the end of the lease term, title revert to Herminio company.
On January 1, 2017, the following data are provided for one of its lease arrangement:
Cost of equipment to Herminio
7,350,000
Residual value – unguaranteed
840,000
Annual rental payable in advance
1,260,000
Useful life and lease term
8 years
Implicit interest rate
12%
First lease payment
January 1, 2017
Required: a. Prepare the journal entries for 2017 and 2018 on the books of Herminio.
a. Prepare the entry on year 2024.
b. Prepare journal entry on January 1, 2025 to record the return of the equipment to
the lessor when the fair value on that date is 700,000.
c. What would be the entry if the residual value is guaranteed.
Answer:
1,260,000*8
=
10,080,000
Add RV
=
840,000
Total
=
10,920,000
Less: Net investment=
7,350,000
UII
=
3,570,000
Lease Receivable
10,920,000
Equipment
7,350,000
Cash
UII
3,570,000
1,260,000
Lease Receivable
1,260,000
12/31/17
UII
730,800
Interest Income
730,800
1/1/18 Cash 1,260,000
Lease receivable
1,260,000
12/31/18
UII
667,296
Interest Income
B. 2024
Cash 1,260,000
Lease Receivable
UII
89,106
Interest Income
667,296
1,260,000
89,106
C. Equipment
700,000
Loss from finanace lease 140,000
Lease Receivable
840,000
D. If guaranteed 2025
Equipment
Cash
Lease receivaable
840,000
Table
1/1/17
1/1/17
1/1/18
1/1/19
1/1/20
1/1/21
1/1/22
1/1/23
1/1/24
1/1/25
1,260,000
1,260,000
1,260,000
1,260,000
1,260,000
1,260,000
1,260,000
1,260,000
840,000
10,920,000
700,000
140,000
730,800
667,296
596,171
516,512
427,293
327,369
215,453
89,106
3,570,000
1,260,000
529,200
592,704
663,829
743,488
832,707
932,631
1,044,547
750,894
7,350,000
7,350,000
6,090,000
5,560,800
4,968,096
4,304,267
3,560,779
2,728,072
1,795,441
750,894
-
Week 13 Answer key
Let’s Check
Matching type: Matched column A with column B.
Column A
1. Under IFRS, a lessee is required to recognize _______________
2. A lease for a twelve months or less.
3. A right of use asset is initially measured at _________
4. A lessee with a lease containing purchase option that is reasonably certain to be exercised
should depreciate the right of use asset over _________.
5. A lease liability is measured at ___________.
6. The lease payments does not ownership expenses such is described as __________
7. What is the interest rate used when the implicit interest rate cannot be determined?
8. It periodically reduces the lessee’s carrying amount of the right of use asset from the
capitalization of a lease.
Column B
a. Executory costs
b. Right of Use Asset and Lease Liability
c. Short term Lease
d. Lessee’s incremental borrowing rate.
e. Useful life of the asset
f. Depreciation
g. Cost
h. Present value of lease payments
i. Fair Value
j. Lease term
True or False
1. The lessee may apply the operating lease model when the lease is both a Short term lease and a low
value lease.
2. The value of an underlying asset is based on the value of the asset when new regardless of the age of
the asset.
3. The cost of right of use asset includes cost of dismantling, removing or restoring the underlying asset
for which the lessee has no present obligation.
4. Lease payments include residual value guarantee of the lessee.
5. Exercise price of a purchase option that is not reasonably certain to be exercised is included in the
lease payments.
6. Initial direct cost incurred by the lessee in a finance lease is refundable upon the lease expiration.
7. The lessee’s carrying amount of the right of use asset from the capitalization of a lease would be
periodically reduced by total lease payment.
Let’s Analyze
Answer the following adapted problems:
Problem 1
On January 1, 2019, Newscast company entered into an 8-year lease of a floor of
building with useful life of 15 years with the following terms:
Annual rental for the first three years payable
At the end of each year
Annual rental for the next five years payable
At the end of each year
Implicit interest rate
PV of an ordinary annuity of 1 at 10% for three periods
PV of an ordinary annuity of 1 at 10% for five periods
PV of 1 at 10% for three periods
540,000
720,000
10%
2.49
3.79
0.75
The lease provides for neither a transfer of title to the lessee nor a purchase option.
Q1
What is the lease liability on January 1, 2019?
Answer: 540,000 * 2.49=1,344,600
720,000 * 3.79= 2,728,800 * . 75= 2, 046,600
Add
1,344,600
Total
3391,200
Q2
What is the interest expense for 2019? .10* 3,391,200= 339,120
Q3
What is the interest expense for 2022? 272,629
1/1/19
3,391,200
12/31/19
540,000
339,120
200,880
3,190,320
12/31/20
540,000
319,032
220,968
2,969,352
12/31/21
540,000
296,935
243,065
2,726,287
12/31/22
720,000
272,629
447,371
2,278,916
Q4
What is the lease liability on December 31, 2022? 2, 278,916
Problem 2
Caeden company leased many assets and capitalized most of the leased assets. On December
31, 2019, the entity had the following balances in relation to a leased equipment:
Right of use asset
3,000,000
Accumulated depreciation
1,837,500
Lease liability
975,000
Depreciation has been recorded up to the end of the current year and no accrued interest is
involved. On December 31, 2019, the entity decided to purchase the equipment for 1,600,000
cash.
What is the cost of the “actual purchase” of the leased equipment?
Answer
3,000,000
Less: A/D
1,837,500
CA
1,162,500
Add Casp Payment
1,600,000
Total
2,762,500
Less: Lease liability
Cost of equipment purchased
975,000
1,787,500
Problem 3
On January 1, 2019, Maliya Company leased equipment from a lessor with the following pertinent
information:
Annual rental payable at the end of each year
750,000
Lease term
8 years
Useful life of equipment
10 years
Implicit interest rate
10%
PV of an ordinary annuity of 1 for 8 periods at 10%
5.33
Present value of 1 for 8 periods at 10%
0.47
The entity has the option to purchase the equipment on January 1, 2027 by paying 750,000.
There is reasonable certainty that the entity shall exercise the option. On January 1, 2019, the
entity incurred initial direct cost of 300,000.
Q1
What is the initial cost of the right of use asset?
Answer: 750,000 * 5.33= 3,997,500
PV of cost
750,000 * .47 = 352,500
BPO
IDC
300,000
4,650,000
Q2
What is the interest expense for 2019? 3,997,500 + 352,500=4,350,000*.1=435,000
Q3
What is the lease liability on December 31, 2019? 750,000-435,000=315,0004350,000= 4,035,000
Q4
What is the depreciation for 2019?4650,000/10=465,000
Problem 4
At the beginning of the current year, Jemima Company entered into an 8-year lease for an
equipment. The entity accounted for the acquisition as a finance lease for 5,400,000 which
included a 540,000 residual value guarantee. At the end of the lease, the asset will revert back
to the lessor.
It is estimated that the fair value of the asset at the end of the 10-year useful life would be
360,000. The entity used the straight line depreciation.
What amount should be recognized as depreciation expense of the right of use asset for the
current year?
Answer 5400,000-540,000= 4860,000/8=607500
In a Nutshell (Adapted)
Your expertise as an excellent accounting student has been sought for by your parents in their
business. You are asked to help them analyze and prepare in advance the necessary entries in
connection with a certain lease entered into for property to be used in the business.
The following data has been provided for your analysis.
The date of the lease is January 1, 2019 for a machinery with a useful life of 8 years. The lease
contract is for a period of 6 years. The implicit interest rate in the lease is 10%.
The following present values are provided:
PV of an annuity due of 1 at 10% for 6 periods
PV of 1 at 10% for 6 periods
4.7908
.5645
The lease contains neither a transfer of title to the lessee nor a purchase option.
The lease requires annual payments of 600,000 beginning January 1, 2019.
The entity had a residual value guarantee of 480,000 when the machinery is returned to the
lessor upon the expiration of the lease.
Required:
1. Prepare the table of amortization of the lease liability and interest expense.
Answer: 600,000 * 4.7908 =2,874,480
PV of RV
.5645*480,000= 270,960
3145,440
1/1/19
1/1/19
1/1/20
1/1/21
1/1/22
1/1/23
1/1/24
1/1/25
600,000
600,000
600,000
600,000
600,000
600,000
480,000
254,544
219,998
181,998
140,198
94,218
43,604
600,000
345,456
380,002
418,002
459,802
505,782
436,396
2. Prepare journal entries for the first three years.
Answer:1/1/2019
Right of Use Asset
3,145,440
Lease Liability
3,145,440
Lease Liability 600,000
Cash
600,000
12/31/19
Interest Expense
254,544
Accrued interest payable
254,544
Depreciation 3,145,440-480,000/6 444,240
Accumulated Depreciation
444,240
2020
January 1
Accrued interest payable
Lease Liability
254,544
345,456
3,145,440
2,545,440
2,199,984
1,819,982
1,401,980
942,178
436,396
-
Cash
Dece. 31
600,000
Interest Expense
219,998
Accrued interest
219,998
Depreciation expense
Accumulated Dep.
444,240
444,240
3. Prepare journal entry on January 1, 2025 to record the return of the machinery to the
lessor. Assume the fair value of the asset is 540,000.
Answer:
Accumulated depreciation
444,240* 6
2,665,440
Lease Liability
436,396
Accrued interest payable
43,604
Right of Use Asset
3,145,440
4. Prepare journal entry on January 1, 2025 to record the return of the machinery to the
lessor. Assume the fair value of the asset is 360,000.
Accum dep
2,665,440
Lease liability
436,396
Accrued interest payable
43,604
Right of use asset
3,145,440
Loss on Finance lease
Cash
480-360
120,000
120,000
Let’s Check
1. Net
investment
in
a
salestypeleaseisequalto
Sum
ofabsoluteamountofleasepaymentsandunguaranteedresidualvalue. (TrueorFalse)
2. Under
a
salestypelease,
grossinvestmentisequaltoGrossinvestment
in
theleaselessunearnedfinanceincome. (TrueorFalse)
3. In
a
salestypelease,
thelessorrecognizes
a
dealer
profit
attheinceptionoftheleaseandinterestrevenue
over
theusefullifeoftheasset.
(TrueorFalse)
4. The
excessofthefairvalueofunderlyingassetattheinceptionofthelease
over
thecarryingamountshallberecognizedbythedealerlessor as manufacture profit from
a salestypelease.
5. Under
a
salestypelease,
thetreatmentofunguaranteedresidualvalue
in
determiningthecostofgoodssoldisdeductedfromthecostoftheunderlyingassetatpres
entvalue.
6. The
gross
profit
of
a
salestypeleasedifferswhenthecaseisunguaranteedresidualvaluecomparedtoguara
nteedone.
7. Undertheunguaranteedandguaranteedresidualvaluescenario,
theamountofcostofsalesdebiteddifferbecausethereisportionofthecostofinventoryw
hichisunsold in guaranteedscenario.
8. The
profit
on
a
financeleasetransactionforlessorswho
are
manufacturersordelaersshouldberecognizedon a straightline basis over thelease
term.
9. The
salesrevenuerecognizedatthecommencementoftheleaseby
a
manufacturerordealerlessoristhefairvalueoftheassetorpresentvalueoftheleasepay
ments, whicheverishigher.
10. Whenthepurchaseoptionisexercised,
thelessorrecognizeslossonfinanceleaseequaltothedifferencebetweenthefairvalueo
ftheassetreturnedandtheresidualvalueguaranteed.
Let’s Analyze
Answer the following adapted problems:
Problem 1
On January 1, 2017, Angelynne company leased equipment to Richelle Company.
Angelynne is a dealer in the said equipment. The lease appropriately accounted for as a sale
by Angelynne Company and as purchase by Richelle.
The period of the lease is for 10 years which is also equal to the useful life of the equipment. The
first annual payment of 400,000 was made on January 1, 2017.
Angelynne company purchased the equipment for 2,140,000 and established a list selling price
of 2,700,000 on the equipment. Angelynne company used the perpetual inventory system.
The present value on January 1, 2017 of the rent payments over the lease term discounted at
12% was 2,532,000.
Prepare journal entries for 2017 and 2018 on the books of Angelynne company.
Answer:
Sales – equal to PV
-Cost of sales
GP
2532000
2140000
392000
2532000-400000=2132000*.12=255,840
Lease Receivable
Sales
UII
4,000,000
400000*10=4000000
2,532,000
1468000
Cost Of Sales 2140,000
Inventory
2140,000
Cash 400,000
Lease Receivable
12/31/2017
Jan. 1, 2018
12/31/2018
400,000
400,000
400000
UII
400,000
255840
Interest Income
Cash 400,000
Lease Receivable
UII
161459
Interest Income
255840
238541
400,000
144160
161459
255840
400,000
161459
2532000
2132,000
1987840
Problem 2
Lireo Company uses the perpetual inventory system and is a dealer in a
machinery. On January 1, 2017 a machinery was leased to Hathoria company with the following
provisions:
Annual rent at the end of each year
2,100,000
Lease term/useful life
5 years
Cost of the machine
5,600,000
Residual value
700,000
Initial direct cost paid by Lireo company
210,000
Implicit rate
12%
PV of an ordinary annuity of 1 for 5 periods at least 12%
PV of 1 for 5 periods at 12%
3.60
0.57
Prepare journal entries on the books of Lireo company assuming that the residual value is
a. guaranteed,
b. Unguaranteed
Answer:
Gross Investment
=2100000*5 + 700000=
11,200,000
Net Investment
=
2100000*3.6=7560000
=
700000*.57=399000
(7959000)
UII
3,241,000
Cost Of Sales =
5600000+210000= 5810000
A. Lease Receivable
Cost Of Sales
Sales
UII
Inventory
Cash
UII
7959000
3241000
5600000
210000
955080
Interest Income
B. Lease Receivable
Cost of Sales
Inventory
Cash
UII
Sales
UII
11200000
5810000
955080
11200000
5411000
5600,000
210000
3241000
7560000
955080
Interest Income
955080
Table of Amortization
1/1/1
12/31/1
2100000
12/31/2
2100000
12/31/3
2100000
12/31/4
2100000
12/31/5
2100000
955080
817690
663812
491470
312948
5600000+210000-399000
same under guaranteed
PV of rentals
1144920
1282310
1436188
1608530
1787052
7959000
6814080
5531770
4095582
2487052
700000
In a Nutshell (Adapted)
You worked for Saturinas Company as an OJT. The compnay is a dealer in equipment. The
entity leased an equipment to Banez company on January 1, 2017 which is appropriately
recorded as a sales type lease. You are asked to present analysis of the account of a certain
lease contract entered into with a specific customer.
The following data are providedforyourimmediateanalysis:
Annual rental payable at the beginning of each year
Lease term
Implicit interest rate
Purchase option
Useful life of the equipment
PV of an annuity of 1 in advance at 10% for 8 periods
PV of 1 at 10% for 8 periods
Cost of Equipment
1,225,000
8 years
10%
420,000
10 years
5.8684
0.4665
4340,000
It is reasonably certain that the lease will exercise the purchase option on the expiration
of lease on December 31, 2024.
Saturinas Company uses perpetual inventory system.
Required: 1. What are the entries for 2017 and 2018and 2019? Answers below
2. Determine the gross profit on sale =
=
Sales – COS=7384720-4340000
3,044720
3. Prepare journal entry on December 31, 2024 to record the exercise of the
bargain purchase option.
Cash 420000
Lease Receivable
420000
4. Prepare journal entry on December 31, 2024 if the bargain purchase option is
not exercised by the lessee and the fair value of the leased asset is 280,000.
Inventory
280000
Loss on Finance Lease
140000
Lease Receivable
420000
5. Explain in not lessthan 20 words, the rule application that set the difference in
entry for number 3 and 4.
Computations:
GI= (1225000*8) + 420000 =
10220000
NI=
1225000*5.8684=7188790
420000 * .4665=195930
7384720
UII
2835280
Cost of Sales Cost + IDC
1.
Lease Receivable
Cost Of Sales
Sales
Inventory
=
4760000
10220000
4340000
7384720
4340000
Cash
UII
UII
2835280
1225000
Lease Receivable
1225000
615,972
Interest Income
615972
Jan. 1, 2018
Cash 1225000
Lease Receivable
12/31/2018
UII
1225000
555069
Interest Income
Jan. 1, 2019
Cash 1225000
Lease Receivable
1225000
12/31/2019
UII
488076
Interest Income
488076
Jan. 1/2017
Jan. 1/2017
Jan. 1/2018
Jan. 1/2019
Jan. 1/ 2020
1225000
1225000
1225000
1225000
615972
555069
488076
555069
1225000
609028
669931
7384720
6159720
5550692
4880761
Let’s Check (Adapted)
1. These are differences that result in future taxable amount in determining
taxable profit in future periods.
a. Temporary differences
c. Deductible temporary differences
b. Taxable temporary differences d. Permanent differences
2. These are differences that result in future deductible amount in determining
taxable profit in future periods.
a. Taxable temporary differences
c. Taxable temporary and
permanent diff.
b. Deductible temporary differences
d. Deductible temporary and
permanent diff.
3. It is the amount attributable to an asset or liability for tax purposes.
a. Carrying amount
c. Measurement base
b. Tax base
d. Taxable amount
4. It is the deferred tax consequence attributable to a deductible temporary
difference and operating loss carry forward.
a. Deferred tax liability
c. Current tax liability
b. Deferred tax asset
d. Current tax asset
5. It is the amount of income tax payable in respect of taxable profit
a. Current tax expense
c. Deferred tax expense
b. Total income tax expense
d. Deferred tax benefit
6. A temporary difference which would result in a deferred tax liability is
a. Interest revenue on municipal bonds
c. Excess tax depreciation
b. Accrual of warranty expense
d. Subscription received in advance
7. A temporary difference which would result in a deferred tax asset is
a. Tax penalty or surcharge.
b. Dividend received on share investment
c. Excess tax depreciation over accounting depreciation
d. Rent received in advance included in taxable income at the time of receipt
but deferred for accounting purposes.
8. Josephine company reported pretax income of 800,000 for the year ended
Dec. 31, 2017.
In the computation of income taxes, the following data were considered:
Nontaxable gain
350,000
Depreciation deducted for tax purposes in
Excess of depreciation for book purposes
50,000
Estimated tax payments in 2017
70,000
Enacted tax rate
30%
What amount should be reported as current tax liability on Dec. 31. 2017?
a. 135,000
b. 120,000
c. 50,000
d. 65,000
9. Mildred company reported the following items for the current year:
Payment of penalty
50,000
Insurance premium on life of an officer with Mildred as beneficiary
100,000
What is total amount of temporary difference?
a. 150,000
b. 100,000
c. 50,000
d. 0
10.Miles company reported pretax accounting income of 200,000 and taxable
income of 150,000 for the current year.
The difference is due to the following:
Interest income on savings deposit
70,000
Premium expense on keyman’s life insurance
(20,000)
Total
50,000
The income tax rate is 30%.
What amount should be reported as current provision for income tax expense
in the income statement for the current year?
a. 45,000
b. 50,000
c. 60,000
d. 0
Let’s Analyze (Adapted)
1.
On January 1, 2014, Difficult company acquired an equipment for 7,200,000. The
equipment is depreciated using straight line method based on a useful life of 8
years with no residual value. On January 1, 2017, after 3 years, the equipment
was revalued at a replacement cost of 10,800,000 with no change in the useful
life.
The pretax accounting income before depreciation for 2017 is 9,000,000. The
income tax rate is 35% and there are no other temporary differences at the
beginning of the year.
What are the revaluation entries on January 1, 2017?
Answer:
HC
RC
App
Eqpt
7200,000/8*3
A/D
2700,000
4,050,000
1,350,000
CA
4500,000
6,750,000
2,250,000
Equipment
3,600,000
10,800,000/8*3
3,600,000
Acc. Depreciation 1,350,000
Revaluation Surplus
2,250,000
Revaluation Surplus 787,500
Deferred Tax Liability
787,500
What are the entries on December 31, 2017?
Income tax expense 9,000,000-900,000=8,100,000*.35
Income tax payable
Deferred Tax liability
157,500
Income tax expense
2,835,000
2,835,000
787,500/5
157,500
Depreciation expense
1,350,000
Accumulated depreciation
6,750,000/5
1,350,000
What is the current tax expense for 2007?
2,835,000
2.
Forever company began operations on January 1, 2019. At the end
of the first year of operations, Tantrum reported 7,000,000 income
before income tax on its income statement but only 6,100,000
taxable income on its tax return. Analysis of the 900,000 difference
revealed that 500,000 was a permanent difference and 400,000 was
a temporary tax liability difference related to a current asset. The
enacted tax rate for 2017 and future years is 30%. What is the total
income tax expense to be reported in the 2019 income statement?
Answer: Total income tax expense= AIST * .30
=
7,000,000-500,000= 6500,000 *.30= 1,950,000
3. On January 1, 2019, Eva company purchased an equipment for 3,000,000 The
equipment has an estimated useful life of 4 years and no residual value. The entity
used the straight line method of depreciation for accounting purposes and the SYD
method for tax purposes.
The depreciation charge is the only timing difference between the accounting income
and taxable income.
Eva company generated 12,000,000 income before depreciation and tax for each of
the four years and that the applicable tax rate is 30%.
a. Computethe SYD depreciation for year 1 to year 4.
Answer: 4/10*3,000,000=
1200,000
3/10*3,000,000= 900,000
2/10*3,000,000= 600,000
1/10*3,000,000= 300,000
b. Prepare journalentries for 4 years and prepare the income statement.
Year 1
Income tax expense
3,240,000
Income tax payable
3,240,000
Income tax expense
135,000
Deferred tax liability
135,000
AI
TI
12,000,000
12,000,000
750,000
1,200,000
11,250,000
10,800,000*.30= 3,240,000
Diff. 450,000*.3=135,000
Income statement
Acctg. Net income before tax
11,250,000
Less: Total Inc. tax exp
CTE 3,240,000
DTL 135,000
Net Income after tax
3,375,000
7,875,000
YEAR 2
Income tax expense
3,330,000
Income tax payable
3,330,000
12,000,000-900,000=11100,000*.3
Income tax expense
45,000
Deferred tax liability
45,000
11100,000-11,250,000= 150,000*.3=45,000
Income statement year 2
Acctg. Net income before tax
Less: Total Inc. tax exp
CTE 3,330,000
DTL 45,000
Net Income after tax
YEAR 3
Income tax expense
3,420,000
Income tax payable
3420,000
11,250,000
3,375,000
7,875,000
12,000,000-600,000=11400,000
11400,000-11,250,000=150,000*.3=45,000
Deferred tax liability
45,000
Income tax expense
45,000
Income statement year 3
Acctg. Net income before tax
Less: Total Inc. tax exp
CTE
3,420,000
DTL reversal
(45,000)
Net Income after tax
YEAR 4
Income tax expense
11,700,000*.30
3510,000
Income tax payable
3510,000
11,250,000
3,375,000
7,875,000
12,000,000-300,000=
Deferred tax liability
135,000
Income tax expense
135,000
11700,000-11250,000=450,000*.3=135,000
Income statement year 4
Acctg. Net income before tax
Less: Total Inc. tax exp
CTE
3,510,000
11,250,000
DTL reversal
Net Income after tax
(135,000)
3,375,000
7,875,000
c. Showall necessary solutions analyzing through the income statement
approach and statement of financial position approach.
In a Nutshell (Adapted)
Matrix company computed a pretax accounting income of 5,000,000 for its first year
of operations ended Dec. 31, 2019. In preparing the income tax return for 2019, the
following differences are noted between accounting income and taxable income.
Nondeductible expenses
250,000
Nontaxable revenue
375,000
Unearned income reported In
Financial statement
(expected to be earned in 2020)
562.500
Provision for doubtful accounts
125,000
Financial depreciation
375,000
Taxdepreciation
437,500
Estimatedwarrantycostaccrued in thecurrentyearbut not
Deductiblefortaxpurposes until paid
125,000
Income tax rate
30%
1. What are the entries to be prepared to recognize the company’s current tax
expense, deferred tax liability and deferred tax asset?
Answer:
Pretax income
5,000,000
Add: Nondeductible expense
250,000
Less: Non taxable revenue
(375,000)
Accounting income subject to tax
4,875,000
Less: Unearned income
(562,500)
Excess tax depreciation
(62,500)
Doubtful accounts
125,000
Warranty expense
125,000
Taxable income
4,500,000
Income tax expense
4500,000*.3 1,350,000
Income tax payable
1,350,000
Deferred tax asset
75,000
Income tax expense
250,000*.3
75,000
Income tax expense
187,500
Deferred tax liability
187,500
625,000*.3=187,500
2. PreparetheIncomestatementpresentingtheincometaxexpense.
Pretax income
5,000,000
Less: Total income tax expense
CTE
1350,000
+DTL
187,500
- DTA
(75,000)
1462500
3537500
3. Determinethe net deferredtaxexpenseorbenefit
187500-75000=112500net deferred tax expense
Let’s Check
Answer the following adapted problems:
1. On December 31, 2019, Ben Company sold a machine to Ryan
Company and simultaneously leased it back for one year. The entity
provided the following information at this date:
Sale price
Carrying Amount
Present value of reasonable lease rentals
(P30,000 for 12 months @ 12%)
Estimated remaining useful life
504,000
462,000
477,400
12 years
In the income statement for 2019, what amount should be reported as gain
from the sale of the machine?
a. 47,740
b. 42,000
c. 5,740
d. 0
2. On December 31, 2019, Lanie Company sold equipment to Noll
Company simultaneously leased back for 3 years.
The leaseback is appropriately considered low value lease.
Sale price
Carrying amount
Estimated remaining economic life
What
a.
b.
c.
d.
576,000
504,000
5 years
amount should be reported as gain from sale of equipment for 2019?
168,000
84,000
56,000
0
Answer not in the choices: it should be 72,000= 576,000-504,000
3. On January 1, 2019, Lemon Company sold equipment to an unaffiliated
entity at the fair value of P3,000,000.
The equipment had a carrying amount of P2,700,000 and a remaining life of
10 years.
That same day, Lee company leased back the equipment at P9,000 per month
for 2 years with no option to renew the lease or repurchase of the equipment.
The present value of the lease payments using the appropriate interest rate
was 191,190 on January 1, 2019.
Q1
What is the initial lease liability?
a. 191,190
b. 95,595
c. 216,000
d. Zero because low value lease
Q2
a.
b.
c.
d.
What is the cost of right of use asset?
216,000
172,071
191,190
Zero
a.
b.
c.
d.
What is the annual depreciation of the right of use asset?
86,035.2
59,595
108,000
Zero
Q3
Q4What is the gain on right transferred to the buyer-lessor?
a. 300,000
b. 280,881
c. 150,000
d. Zero
Let’sAnalyze
Answer the following adapted problems:
Problem 1. Yasmin Company sold a machine and immediately leased it back
at market rental on January 1, 2017.
The following data are gathered in connection with the lease back transaction:
Selling price
3,750,000
Fair value of machine
3,750,000
Carrying amount of machine
3,375,000
Annual rental
450,000
Remaining life of machine
10 years
Lease term
5 years
Implicit interest rate
10%
Present value of an ordinary annuity of 1 at 10% for 5 periods
3.791
The lease back provides for neither transfer of title to the lessee nor a
purchase option that is reasonably certain to be exercised.
Required:
Q1
Computetheinitialmeasurementofleaseliability.1705,950
Q2
Computethecostofrightofuseasset. =
1535,355
Q3
Determinethe gain onrighttotrasferredtothebuyer - lessor.= 204405
Problem 2
The following data are gathered from the sale and lease back transaction
entered into on January 1, 2017 by Lovell Company, theseller:
Selling price
3,600,000
Fair value of machine
3,000,000
Carrying amount of machine
2,700,000
Annual rental payable at the end of each year
480,000
Remaining life of machine
10 years
Lease term
4 years
Implicit interest rate
8%
Present value of an ordinary annuity of 1 at 8% for 4 periods
3.312
Their agreement did not provide for transfer of title nor purchase option that
is reasonably certain to be exercised.
Q1
Computetheinitialleaseliability.
=
1,589,760
Q2
Computethecostofrightofuseasset.=
890,784
Q3
Determinethe gain onrighttransferredtobuyer-lessor.=
201,024
Problem 3
At the beginning of current year, an entity sold an equipment with remaining
life of 10 years and immediately leased it back for 4 years at the prevailing
market rental.
Sales price at fairvalue
5,400,000
Carrying amount of equipment
4,050,000
Annual rental payable at the end of eachyear
720,000
Implicit interest rate
10%
Present value of an ordinary annuity of 1 at 10% for four periods
3.17
Q1
What is the initial lease liability? = 720,000 (3.17)=2,282,400
Q2
What
is
the
cost
of
right
of
use
asset?=
2,282,400/5400,000*4,050,000= 1,711,800
Q3
What
is
the
gain
on
right
transferred?
5400,0002282400=3117600/5400,000*1350,000= 779400
Q4
Q5
What is the annual depreciation of the lessee?=1711800/4=427,950
Prepare the entries on the books of the lessee for the 4 years.=
In a Nutshell (Adapted)
On January 1, 2019, Ramzel company sold a machine and immediately leased it back.
The following data pertain to the sale and leaseback transaction:
Sales price at below fair value
4,800,000
Fair value of machine
6,000,000
Carrying amount of machine
4,200,000
Annual rental payable at the end of each year
600,000
Remaining life of machine
10 years
Lease term
3 years
Implicit interest rate
6%
Present value of an ordinary annuity of 1 at 6%
For 3 periods
2.673
The lease provides for neither trasnfer of title to the lessee upon lease expiration nor
a purchase option that is reasonably certain to be exercised.
Case 1
Sales price is below fair value
Q1
Compute for the initial lease liability. = 600,000*2.67=1602000
Q2
Compute for the cost of right of use asset.
=
FV-SP= 6,000,000-4800,000= 1200,000
Initial Lease liab+ Excess = 1602,000- 1200,000= 2802,000
2802000/6,000,000*4200,000=1961400
Q3
Determine the gain on right transferred to buyer-lessor.
FV-CA =
6,000,000-4200,000=1,800,000
FV-right retained= 6,000,000-2802,000=3198000/6,000,000*1800,000=959,400
Q4
Entries
Seller-lessee’s book
Cash
4800,000
Right of use Asset 1961,400
Machinery
4200,000
Lease Liability
1602000
Gain on right transferred 959400
Interest expense1602,000*6%
Lease liability
Cash
96,120
503,880
600,000
Depreciation
1961400/3 653800
Accumulated depreciation
653800
Books of Buyer-lessor
Machinery 4800,000
Cash
4800,000
Cash 600,000
Rental Income
600,000
Depreciation 480,000
Accumulated Depreciation
480,000
Q5
In not less than 20 words, be able to explain your answer from question 1 to
4.
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