IX – AUDIT OF LIABILITIES
PROBLEM NO. 1 – Current and noncurrent liabilities
You were able to obtain the following from the accountant for Agdangan Corp. related to the company’s
liabilities as of December 31, 2010.
Accounts Payable
Notes Payable
Payable – trade
Notes Payable
Payable – bank
Wages and salaries payable
Interest payable
Mortgage notes payable – 10%
Mortgage notes payable – 12%
Bonds Payable
P
650,000
190,000
800,000
15,000
?
600,000
1,500,000
2,000,000
The following additional information pertains to these liabilities.
a. All trade notes payable are due within six months from the end of the reporting period.
b. Bank notes-payable include two separate notes payable to Allied Bank.
(1) A P300,000, 8% note issued March 1, 2008, payable on demand. Interest is payable every sixmonths.
(2) A 1-year, P500,000, 11 ½ % not issued January 2, 2010. On December 30, 2010, Agdangan
negotiated a written agreement with Allied Bank to replace the note with a 2-year, P500,000,
10% note to be issued January 2,2011. The interest was paid on December 31, 2010.
c. The 10% mortgage note was issued October 1, 2007, with a term of 10 years. Terms of the note
give the holder the right to demand immediate payment if the company fails to make a monthly
interest payment within 10 days of the date the payment is due. As of December 31, 2016,
Agdangan
Agdanga
n is three months behind in paying its required interest payment.
d. The 12% mortgage note was issued May 1,2004, with a term of 20 years. The current principal
amount due is P1,500,000. Principal and interest payable annually on April 30. A payment of
P220,000 is due April 30, 2011. The payment includes interest of P180,000.
e. The bonds payable is 10-year, 8% bonds, issued June 30, 2001. Interest is payable semi-annually
every June 30 and December 31.
QUESTIONS:
Based on the above and the result of your audit, answer the following.
1. Interest payable as of December 31, 2010 is
a. P155,000
c. P143,000
b. P203,000
d. P215,000
2. The portion of the Note Payable-ba
Payable-bank
nk to be reported under current liabilities as of December 31,
2010 is
a. P300,000
c. P500,000
b. P800,000
d. P
0
3. Total current liabilities as of December 31, 2010 is
a. P3,950,000
c. P4,138,000
b. P3,938,000
d.
P
0
4. Total noncurrent liabilities as of December 31, 2010 is
a. P1,760,000
c.
P2,560,000
b. P3,960,000
d. P1,960,000
Answers: 1)C
2)A
3)B
4)D
Suggested Solution:
Question No. 1
P300,000 note payable to bank (P300,000 x 8% x 4/12)
Mortgage note payable – 10% (P600,000 x 10% x 3/12)
Mortgage note payable – 12% (P1,500,000 x 12% x 8/12)
Total interest payable, 12/31/10
P
8,000
15,000
120,000
143,000
Question No. 2
Note payable
payable to bank
bank – payable on demand
P 300,000
The
payable31,
to bank
termP500,000
basis as ofnote
December
2010.will be classified as noncurrent because it was refinanced on a long
Question No. 3
Accounts Payable
Notes Payable
Payable – trade
Notes Payable
Payable – bank (see no. 2)
Wages and salaries payable
Interest payable (see no. 1)
Mortgage note payable – 10% (with breach of loan covenant)
Mortgage note payable – 12% (P220,000 – P180,000)
Bonds payable, due 7/1/11
Total current liabilities, 12/31/10
P
650,000
190,000
300,000
15,000
143,000
600,000
40,000
2,000,000
P3,938,000
In accordance
accordance with the revised
revised PAS 1 par. 69, an entity shall
shall classify a liability as current when:
(a)
(b)
(c)
(d)
it expects to settle the liability in its normal operating cycle;
it holds the liability primarily for the purpose of trading;
the liability is due to be settled within twelv
twelvee months after the reporting period; or
the entity does not have an unconditional right to defer settlement of the liability for at least
twelve months after the reporting period.
An entity shall classify
classify all other
other liabilities
liabilities as non
non-current.
-current.
When an entity breaches an undertaking under a long-term loan agreement on or before the end of the
reporting period with the effect that the liability becomes payable on demand, the liability is classified as
current, even if the lender has agreed, after the reporting period and before the authorization of the
financial statements for issue, not to demand payment as a consequence
consequence of the breach. The liability is
current, because at the end of the reporting period, the entity does not have an unconditional right to defer
its settlement for at least twelve months after that date. (PAS 1 par. 74)
However, the liability
liability is classifies
classifies as non-current if the lender
lender agre
agreed
ed by the end of the reporting period to
provide a period
period of grace
grace ending
ending at least
least 12 months after
after the reporting period,
period, within
within which the entity can
rectify the breach and during which the lender cannot demand immediate repayment. [PAS 1 par. 75]
Question No. 4
Notes payable
payable – bank (see no. 2)
Mortgage note payable – 12% (P1,500,000 – P40,000)
Total noncurrent liabilities, 12/31/10
P
500,000
1,460,000
P 1,960,000
PROBLEM NO. 2 – Current and noncurrent liabilities
Atimonan Corporation is selling audio and video appliances. The company’s fiscal year ends on March 31.
The following information relates to the obligations of the company as of March 31, 2010:
Notes Payable
Payable
Atimonan has signed several long-term notes with financial institutions. The maturities of these notes are
given below. The total unpaid interest for all of these notes amounts to P408,000 on March 31, 2010.
Due date
April 31, 2010
July 31, 2010
September 1, 2010
February 1, 2011
April 1, 2011 – March 31, 2012
Amount
P 720,000
1,080,000
540,000
540,000
3,240,000
P 6,120,000
Estimated warranties
Atimonan has a one-year product warranty on some selected items. The estimated warranty liability in sales
made during the 2008-2009 fiscal year and still outstanding as of March 31, 2009, amounted to P302, 400.
The warranty costs on sales made from April 1, 2009 to March 31, 2010, are estimated at P756,0 00. The
actual warranty costs incurred during 2009-2010 fiscal
f iscal year are as follows:
Warranty claims honored on 2008-2009 sales
Warranty claims honored on 2009-2010 sales
Total
P 302,400
342,000
P 644,400
Trade payables
Accounts payable for supplies, goods, and services purchases on open account amount to P672,000 as of
March 31, 2010.
Dividends
On March 10, 2010, Atimonan’s board of directors declared a cash dividend of P0.30 per o rdinary share
and a 10% ordinary share dividend. Both dividends were to be distributed on April 5, 2010 to shareholders
on record at the close of business on March 31, 2010. As of March 31, 2010 Atimonan has 6 million, P2
par value, ordinary shares
shares issued and outstanding.
outstanding.
Bonds payable
Atimonan issued P6,000,000, 12% bonds, on October 1, 2004 at 96. The bonds will mature on October 1,
2014. Interest is paid semi-annually on October 1 and April 1. Atimonan uses the straight line method to
amortize bond discount.
QUESTIONS:
Based on the foregoing information, determine the adjusted balances of the following as of March 31,2010:
1. Estimated warranty payable
a. P414,000
b. P756,000
c. P 302,400
d. P1,058,400
2. Unamortized bond discount
a. P132,000
b. P108,000
c. P 240,000
d. P 120,000
3. Bond interest payable
a. P360,000
b. P300,000
c. P 180,000
d. P
0
4. Total current liabilities
a. P7,734,000
b. P6,126,000
c. P 6,534,000
d. P 4,734,000
5. Total noncurrent liabilities
a. P9,240,000
b. P9,132,000
c. P 9,108,000
d. P 9,000,000
Answers: 1) A 2) B
3) A
4) C
5) B
Suggested Solution:
Question No. 1
Warranty payable, 3/31/09
Add warranty expense accrued during 2009-2010
Total
Less payments during 2009-2010
Warranty payable, 3/31/10
P 302,400
756,000
1,058,400
644,400
P 414,000
Question No. 2
Bond discount, 10/1//04 (P6,000,00
(P6,000,000
0 x .04)
Discount amortization,
amortization, 10/1/04 to 3/31/10 (P240,000 x 5.5/10)
Bond discount, 3/31/10
P 240,000
132,000
P 108,000
Question No. 3
Bond interest payable, 10/1/09 to 3/31/10 (P6,000,00
(P6,000,000
0 x 12% x 6/12)
P 360,000
Question No. 4
Notes payable
payable – current (maturing up to 3/31/11)
Accrues interest payable – Notes Payable
Estimated warranty payable (see no. 1)
Accounts payable
Cash dividend payable (6 million shares x P0.30)
Accrued interest payable – Bonds payable
Total current liabilities
P 2,880,000
408,000
414,000
672,000
1,800,000
360,000
P 6,534,000
Question No. 5
Notes payable
payable – noncurrent
Bonds payable, net of discount of P108,000
Total noncurrent liabilities
P 3,240,000
5,892,000
P 9,132,000
PROBLEM NO. 3 – Various current liabilities
The following information relates to Candelaria Company’s obligations as of December 31, 2010. For each
of the numbered items, determine the amount if any, that should be reported as current liability in the
Candelaria’s December 31, 2010 statement of financial position.
position .
1. Accounts payable:
Accounts payable per general ledger control amounted to P5,440,000, net of P240,000 debit
balances in suppliers’
suppliers’ accounts. The unpaid voucher
voucher file included the following items
items that had
had not
been recorded
recorded as of
of December
December 31, 2010:
2010:
a) A Company – P244,000 merchandise shipped on December 31, 2010, FOB destination;
received on January 10, 2011.
b) B, Inc. – P192,000 merchandise shipped on December 26, 2010, FOB shipping point; received
on January 16, 2011.
c) C Super Services – P144,000 janitorial services for the three-month period ending January 31,
2011.
d) MERALCO – P67,200 electric bill covering the period December 16, 2010 to January 15, 2011.
On December 28, 2010, a supplier authorized Candelaria to return goods billed at P160,000 and
shipped on December 20, 2010. The goods were returned by Candelaria on December 28, 2010,
but the P160,000
P160,000 credit
credit memo
memo was not received
received until
until January 6, 2011.
a. P5,923,200
b. P5,601,600
c.
d.
P5,712,000
P5,841,600
2. Payroll:
Items related to Candelaria’s payroll
payroll as of December 31, 2010 are:
Accrued salaries and wages
P776,000
Payroll deductions for:
Income taxes withheld
56,000
SSS contributions
64,000
Philhealth contributions
contributions
16,000
Advances to employees
a. P776,000
b. 832,000
80,000
c.
d.
P992,000
P912,000
3. Litigation:
In May, 2010, Candelaria became involved in a litigation. The suit being contested, but
Candelaria’s lawyer believes there is probable that Candelaria may be held liable for damages
estimated in the range between P2,000,000 and P3,000,000 and no amount is a better estimate of
potential liability than any other amount.
amount.
a. P
0
b. P3,000,000
c.
d.
P2,000,000
P2,500,000
4. Bonus obligation:
Candelaria Company’s president gets an annual bonus of 10% of net income after bonus and
income tax. Assume the tax rate of 30% and the correct income before
bef ore bonus and tax is P9,600,000.
P9,600, 000.
(Ignore the effects of other given items on net income.)
a. P 722,600
b. P2,240,000
c.
d.
P395,000
P628,000
5. Note payable:
payable:
A note payable to the Bank of the Philippine Islands for P2,400,000 is outstanding on December
31, 2010. The note is dated October 1, 2009, bears interest at 18%, and is payable in three equal
annual installment of P800,000. The first interest and principal payment was made on October 1,
2010.
a. P800,000
b. P 72,000
c. P908,000
d. P872,000
6. Purchase commitment:
During 2010, Candelaria entered in a noncancellable commitment to purchase 320,000 units of
inventory at fixed price of P5 per unit, delivery to be made in 2011. On December 31, 2010 the
purchase price of this inventory item had fallen to P4.40 per unit. The goods covered by the
purchase contract were
were delivered
delivered on January 28, 2011.
a. P
0
b. P1,408,000
c. P1,600,000
d. P 192,000
7. Deferred taxes:
On December 31, 2010, Candelaria’s deferred income tax account has a 2010 ending credit balance
of P772,800, consisting of the following items:
Caused by temporary differences in accounting
For gross profit on installment
installment sales
For depreciation on property and equipment
For product warranty expense
a. P772,800
b. P196,800
c.
d.
Deferred tax
P376,000 Cr
576,000 Cr
179,200 Dr
P772,000 Cr
P952,000
P
0
8. Product warranty:
Candelaria has one year product warranty on selected items in its product line. The estimated
warranty liability on sales made during 2009, which was outstanding as of December 31, 2009,
amounted to P416,000. The warranty costs on sales made in 2010 are estimated at P1,504,000.
Actual warranty costs incurred during 2010 are as follows:
Warranty claims honored on 2009 sales
Warranty claims honored on 2010 sales
Total warranty claims honored
a. P
0
b. P96,000
P 416,000
992,000
P 1,408,000
c. P1,504,000
d. P 512,000
9. Premiums:
To increase sales, Candelaria Company inaugurated a promotional campaign on June 30, 2010.
Candelaria placed a coupon redeemable for a premium in each package of product sold. Each
premium costs
costs P100. A premium is
is offered to customers who send in 5 coupons
coupons and a remittan
remittance
ce
of P30. The distribution cost per premium is P20. Candelaria estimated that only 60% of the
coupons issued will be redeemed. For the six months ended December 31, 2010, the following is
available:
Packaged of product sold
160,000
Premiums purchased
16,000
Coupons redeemed
64,000
a. P1,728,000
c. P1,152,000
b. P1,600,000
d. P 576,000
10. Due to Five Six Finance company:
Candelaria’s accounting records show that as of December 31, 2010, P1,280,000 was due to Five
Six Finance Company for advances made against P1,600,000 of trade accounts receivable assigned
to the finance company with recourse.
a. P
0
c. P1,600,000
b. P 320,000
d. P1,280,000
Answers: 1)D
2)D
3)D
4)D
5)D
6)D
7)D
8)D
9)D
10)D
Suggested Solution:
Question No. 1
Accounts payable per general ledger
Debit balances in suppliers’ accounts
Goods in transit on 12/31/10, FOB shipping point
Unrecorded purchase return
Accounts payable, as adjusted
Accrued janitorial expenses (P144,000 x 2/3)
Accrued utilities (P67,200 x 15/30)
Total
P5,440,000
240,000
192,000
(160,000)
5,712,000
96,000
33,600
P5,841,600
Question No. 2
Accrued salaries and wages
Income taxes withheld
SSS contributions
contributi ons payable
Philhealth contributions
contributio ns
Total
P776,000
56,000
64,000
16,000
P912,000
Question No. 3
Midpoint of the range [(P2,000,000
[(P2,000,0 00 + P3,000,000)/2]
P3,000,000)/ 2]
P2,500,000
PAS 37 par. 36 states that the amount recognize
recognized
d as a provision should be the best estimate of the
expenditure required to settle the present obligation at the end of the reporting period. Par. 39 further
states that where
where there
there is a continuous
continuous range
range of possible
possible outcomes,
outcomes, and each point
point in that range is a likely
as any other, the mid-point of the range is used.
Question No. 4
B = 10% (P9,600,000 – B – T)
T = 30% (P9,600,000 – B)
T = P2,880,000 - .3B
B = 10% [P9,600,000 – B – (P2,880,000 - .3B)]
B = 10% (P9,600,000 – B – P2,880,000 + .3B)
B = 10% (P6,720,000 - .7B)
B = P672,000 - .07B
1.07B = P672,000
B = P628,000 (rounded
(rounded off)
Question No. 5
Principal amount due, 10/1/11
Accrued interest payable (P1,600,000 x 18% x 3/12)
Total
P800,000
72,000
P872,000
Question No. 6
Estimated liability for purchase commitment [320,000 x (P5 – P4.40)]
P192,000
If an entity has a contract that is onerous, the present obligation under the contract shall be recognized
and measured as a provision. (PAS 37 par. 66)
An onerous contract is a contract in which the unavoidable costs of meeting the obligations under the
contract exceed the economic benefits expected to be received under it.
Question No. 7
The revised PAS 1 par. 56 states that when an entity presents current and non-current assets, and
current and non-current liabilities, as separate classifications on the face of the statement of
financial position, it shall
shall not cclassify
lassify deferred
deferred tax
tax assets
assets (liabilities)
(liabilities) as current assets (liabilities)
(liabilities)..
Question No. 8
Warranty payable, 12/31/09
P
416,000
Add: Warranty expense accrued during 2010
1,504,000
Total
1,920,000
Less: Payments
Payments during 2010
Warranty Payable, 12/31/10
1,408,000
P
512,000
Question No. 9
Estimated coupons to be redeemed (160,000 x 60%)
96,000
Less coupons redeemed
64,000
Coupons outstanding
32,000
Divide by exchange rate
Premiums to be issued
Multiply by net premium cost (P100 + P20 – P30)
Estimated liability for coupons, 12/31/10
5
6,400
P90
P576,000
Question No. 10
This transaction involves assignment of accounts receivable, wherein the company obtained a loan
using the receivable as security. Accounts receivable – assigned will be included in trade and other
receivables, while the related loan will be reported under current liabilities.
PROBLEM NO. 4 Estimated liabilities – warranty and premium
Dolores’ Music Emporium
Emporiu m carries a wide variety of music promotion techniques – warranties and premiums
– to attract customers.
Musical instrument and sound equipment
eq uipment are sold in a one-year warranty for replacement
r eplacement of parts and labor.
The estimated warranty cost, based on past experience, is 2% of sales.
The premium is offered on the recorded and sheet music. Customers receive a coupon for each peso spent
on recorded music or sheet music. Customers may exchange 200 coupons and P20 for an AM/FM radio.
Dolores pays P34 for each radio and estimates that 60% of the coupons given to customers will be
redeemed.
Dolores’ total sales for 2010 were P57,600,000 – P43,200,000 from musical instrument and sound
reproduction equipment and P14,400,000 from recorded music and sheet music. Replacement parts and
labor for warranty work totaled P1,312,000 during 2010. A total of 52,000 AM/FM radio used in the
premium program were purchased during the year
year and there were 9,600,000 coupons redeemed
redeemed in 2010.
The accrual method is used by Dolores to account for the warranty and premium costs for financial reporting
purposes. The balance in the accounts related to warranties and premiums
premiums on January 1, 2010, were as
shown below:
Inventory of Premium AM/FM radio
Estimated Premium Claims Outstanding
Estimated Liability from Warranties
P 319,600
358,000
1,088,000
QUESTIONS:
Based on the above and the result of your audit, determine the amounts that will be shown on the 2010
financial statements for the following:
1. Warranty expense
a. P 864,000
b. P1,152,000
c. P1,312,000
d. P 640,000
2. Estimated liability from warranties
a. P 864,000
c. P1,088,000
b. P1,312,000
d. P 640,000
3. Premium expense
a. P 604,800
c.
b. P1,468,800
d.
4. Inventory of AM/FM radio
a. P375,600
c.
b. P319,600
d.
5. Estimated liability for premiums
a. P604,800
c.
b. 291,200
d.
Answers: 1) A; 2) D;
3) A;
4) D;
P 864,000
P 1,008,000
P 618,800
P 455,600
P 507,600
P 358,400
5) B
Suggested Solution:
Question No. 1
Warranty expense (P43,200,000
(P43,200,00 0 x 2%)
Question No. 2
P864,000
Estimated liability from warranties, 1/1/10
P1,088,000
Add: Warranty expense for 2010
864,000
Total
1,952,000
Less: Actual expenditures
expenditures for 2010
1,312,000
Estimated liability from warranties, 12/31/10
640,000
Question No. 3
Premium expense [(14,400,000 x 60%)/ 200 x P14]
P604,800
Question No. 4
Inventory of premium,
premium, 1/1/10
P
319,600
Add: Premium purchases (52,000 x P34)
1,768,000
Total premium available
2,087,600
Less: Premiums issued (9,600,000/200
(9,600,000/2 00 x P34)
1,632,000
Inventory of premium, 12/31/10
455,600
Question No. 5
Estimated premium claims outstanding, 1/1/10
P358,400
Add: Premium expense for 2010
604,800
Total
963,200
Less: Premiums issued (P 9,600,000/200
9,600,000/200 x P14)
672,000
Estimated premium claims outstanding, 12/31/10
291,200
contingent liabilities
PROBLEM NO. 5 – Provisions and contingent
The following information relates to Alabat Company as of December 31, 2010. Answer the following
questions relating to each of the independent situations as requested.
1. Beginning
Alabat Company
beganamarketing
a new
called
“Red Colt.”
To help
promote
the product,2010,
the management
is offering
special beer
mugbeer
to each
customer
for every
20 specially
marked bottle caps of Red Colt. Alabat estimates that out of the 300,000 bottles of Red Colt sold
during 2010m only 50% of the marked bottle
bot tle caps will be redeemed. For the year 2010, 8,00
8,000
0 mugs
were ordered by the company at a total cost of P360,000. A total of 4,500 mugs were already
distributed to customers. What is the amount of the liability that Alabat Company should report on
its December 31, 2010 statement of financial position?
a. P135,000
c. P337,500
b. P202,500
d. P360,000
2. On January 2, 2008, Alabat Company introduced a new line of products that carry a three-year
warranty against factory defects. Estimated warranty costs related to peso sales are as follows: 1%
of sales in the year of sale, 2% in the year after sales and 3% in the second year after sale.
Sales and actual warranty expenditures
expenditures for the period 2008 to 2010 were as follows:
2008
2009
2010
Sales
P100,000
250,000
350,000
P700,000
Actual Warranty Expenditures
P 750
3,750
11,250
P15,750
What amount should Alabat report as warranty expense in 2010?
a. P 3,500
c. P11,500
b. P 11,250
d. P21,000
3. During 2010, Alabat Company guaranteed a supplier’s P500,000 loan from a bank. On October 1,
2010, Alabat was notifies that the supplier had defaulted on the loan and filed for bankruptcy
protection. Counsel believes Alabat will probably have to pay between P250,000 and P450,000
under its guarantee. As a result of the supplier’s bankruptcy, Alabat entered into a contract in
December 2010 to retool its machines so that Alabat could accept parts from other suppliers.
Retooling costs are estimated to be P300,000. What amount should Manfred report as a liability in
its December 31, 2010, statement of financial position?
a. P250,000
c. P350,000
b. P450,000
d. P650,000
A
court case
on 21
2010
awarded
damages
Alabat.
The
judge
has
announced
thatdecided
the amount
of December
damages will
be set
at a future
date, against
expected
to be in
March
2011.
Alabat has received advice from its lawyers that the amount of the damages could be anything
between P20,000
P20,000 and P7,000,000. As of December 31, 2010, how much should be recognized in
the statement of financial position regarding this court case?
a. P 20,000
b. P3,150,000
c. P7,000,000
d. P
0
Alabat’s directors decided on 3 November 2010 to restructure the company’s operations as follows:
a) Factory T would be closed down and put on the market for sale.
b) 100 employees working in Factory T would be retrenched effective 30 November 2010 and
would be paid their accumulated entitlements plus
p lus 3 months’ wages.
c) The remaining 20 employees working in Factory T would be transferred to Factory X, which
would continue operating.
d) 5-head-office staff would be retrenched effective 31 December 2010 and would be paid their
accumulated entitlements plus 3 month’s wages.
As at 31 December 2010 the following transactions and events had occurred:




Factory T was shut down on 30 November 2010. An offer of P80M had been received for
Factory T; however there was no binding sales agreement
The 100 employees had been retrenched, had left and their accumulated entitlements had been
paid, however an amount of P1,520,000
P1,520,000,, representing a portion of the 3 months’ wages for
the retrenched employees, had still not been paid.
Costs of P460,000 were expected to be incurred in transferring the 20 employees to their new
work in Factory X. The transfer will occur on 15 January
J anuary 2011.
Four of the five-head-office staff had been retrenched, had left and their accumulated
entitlements, including the 3 months’ wages, had been paid. However one employee, D.
Terminator, remained on to complete administrative tasks relating to the closure of Factory T
and the transfer of staff to Factory X. D. Terminator was expected to stay until 31 January
2011. D. Terminator’s salary for January would
would be P80,000 and his retrenchment package
would be P260,000, all of which would be paid on the day he left. He estimated that he would
spend 60% of his time administering the closure of Factory T, 30% of his time administering
the transfer of staff to Factory X and the remaining 10% on general administration.
administration.
Calculate the amount of the restructuring provision to be recognized in Alabat’s financial
statements as at 31 December 2010.
a. P 116,000
b. P1,828,000
Answers: 1) A;
c. P93,000
d. P89,000
2) D;
3) C;
4) D;
5) B;
Suggested Solution:
Question No. 1
Total estimated mugs to be issued
[(300,000
[(300,00
0 x 50%)/20]
7,500
Less mugs issued
4,500
Balance
3,000
Multiply by premium cost (P360,000/8,000)
(P360,000/8, 000)
Estimated premium liability, 12/31/10
45
P135,000
Question No. 2
Warranty expense for 2010 (P350,000 x 6%)
P21,000
Question No. 3
Provision for guarantee,
guarantee, 12/31/10
[(P250,000 + P450,000) / 2]
P350,000
A provision is a liability of uncertain timing or amount. The amount recognized as a provision
shall be the best estimate of the expendi
expenditure
ture required
required to settle the
the prese
present
nt obligation
obligation at the end of
the reporting period. (PAS 37 par. 36)
Where there is a continuous range of possible outcomes, and each point in that range is as likely
as any other, the mid-point of the range is used (PAS 37 par. 39)
Question No. 4
There is a present obligation and the obligating event has occurred, however the amount cannot
be reliably measured as the estimated range is too great. Therefore,
Therefor e, no liability can be recognized.
This will only be disclosed as a contingent liability.
Question No. 5
Unpaid salaries of retrenched employees
D. Terminator’s retrenchment package
P1,520,000
260,000
D. Terminator’s salary related to administration of the closure
(P80,000 x 60%)
48,000
P1,828,000
A restructuring
restructuring is a program that is planned and controlled
controlled by management,
management, and materially
changes either:
(a) The scope of a business undertaken by an entity; or
(b) The manner in which that business is conducted
conducted..
A restructuring
restructuring provision shall include only the direct expenditures
expenditures arising from the restructuring,
restructuring,
which are those that are both
(a) Necessarily
Necessarily entailed
entailed by the restructuring;
restructuring; and
(b) Not associated
associated with the ongoing activities
activities of the entity.
(PAS 37 par. 80)
A restructuring
restructuring provision
provision does not include such costs
costs as:
(a) Retaining or relocating continuing staff;
(b) Marketing
Marketing;; or
(c) Investment in new systems
systems and distribution networks.
These expenditures relate to the future conduct of the business and are not liabilities for
restructuring at the end of the reporting period. Such expenditures are recognized on the same
basis as if they arose independently of a restructuring.
liabilities, and con
contingent
tingent assets
assets
PROBLEM NO. 6 – Provisions, contingent liabilities,
Burdeos Corporation, a listed company, is a manufacturer of confectionery and biscuits. Its end of
reporting period is December 31 Relevant extracts from its financial statements at 31 December
2009 are as follows:
Current liabilities
Provision
Provision for warranties
P270,000
Non-current liabilities
liabilities
Provision
Provision for warranties
P180,000
Note 36 – Contingent liabilities
Burdeos is engaged in litigation with various parties in relation to allergic reactions to
traces of peanuts alleged to have been found in packets of fruit gums. Burdeos strenuously
denies the allegations and, as at the date of authorizing the financial statements for issue,
is unable to estimate the financial effect, if any, of any costs or damages that may be
payable to the plaintiffs.
plaintiffs.
The provision for warranties at December 31, 2009 was calculated using the following
assumptions: There was no balance carried forward from the prior year.
Estimated cost of repairs – products with minor defects
P1,000,000
Estimated cost of repairs – products with major defects
P6,000,000
Expected % of products sold during 2009 having no
Defects in 2010
80%
Expected % of products sold during 2009 having
Minor defects in 2010
15%
Expected % of products sold during 2009 having
Major defects in 2010
5%
Expected timing of settlement of warranty payments
-
Those with minor defects
Expected timing of settlement of warranty payments
-
Those with major defects
During the year ended December 31, 2010 the following occurred:
All in 2010
40% in 2010
60% in 2011
1. In relation to the warranty provision of P450,000 at December 31, 2009, P200,000 was paid out of
the provision. Of the amount paid, P150,000 was for products with minor defects and P50,000 was
for products with major defects, all of which related to amounts that had been expected to be paid
in 2010.
2. In calculating its warranty provision for December 31, 2010, Burdeos made the following
adjustments to the assumptions used for the prior year:
Estimated cost of repairs – products with minor defects
No change
Estimated cost of repairs – products with major defects
P5,000,000
Expected % of products sold during 2010 having no
Defects in 2011
85%
Expected % of products sold during 2010 having
Minor defects in 2011
13%
Expected % of products sold during 2010 having
Major defects in 2011
2%
Expected timing of settlement of warranty payments
-
Those with minor defects
Expected timing of settlement of warranty payments
-
Those with major defects
All in 2011
40% in 2011
60% in 2012
3. Burdeos determined that part of its plant and equipment needed an overhaul – the conveyer belt on
one of its machines would need to be replaced in about December 2011 at an estimated cost of
P250,000. The carrying amount of the conveyer belt at December 31, 2009 was P140,000. Its
original cost was P200,000..
4. Burdeos was unsuccessful in its defense of the peanut allergy case and was ordered to pay
P1,500,000 to the plaintiffs. As at December 31, 2010 Burdeos had paid P800,000.
5. Burdeos commenced litigation against one of its advisers for negligent advise given on the original
installation
installatio
n of the conveyers belt referred to in (4) above. In October 2010 the court found in favor
of Burdeos. The hearing for damages had not been scheduled as at the date the financial statements
for 2010 were authorized
authorized for issue. Burdeos estimated that it would receive about P425,000.
6. Burdeos signed an agreement with Craft Bank to the e Burdeos would guarantee a loan made by
Craft Bank to the subsidiary, Burgis Ltd. Burgis’ loan with Craft B P3,200,000 as at December 31,
2010. Burgis was in financial position at December 31, 2010.
QUESTIONS:
Based on the above and the result of your audit, answer the ffollowing
ollowing
1. The warranty expense in 2010 is
a. P100,000
b. P160,000
c. P400,000
d. P230,000
2. The provision for warranties as of December 31, 2010 is
a. P580,000
c. P230,000
b. P480,000
d. P410,000
3. The provision for warranties to be reported as current liabilities
liabilities on December 31, 2010 is
a. P220,000
c. P150,000
b. P400,000
d. P330,000
4. The provision for warranties to be reported as noncurrent as of December 21, 2010 is
a. P 80,000
c. P260,000
b. P150,000
d. P330,000
5. Total provisions to be reported in the statement of financial position as of December 31, 2010 is
a. P 480,000
c. P 410,000
b. P1,180,000
d. P1,360,000
Answers: 1) B; 2) D; 3) A; 4) A; 5) C
Suggested Solution:
Question No. 1
No defects – 85%
P
0
Minor defects (P1,000,000
(P1,000,00 0 x 13%)
130,000
Major defects (P5,000,000 x 2%)
100,000
Increase in provision in 2010
230,000
Unused amounts reversed in 2010 (P270,000 – P200,000)
( 70,000)
Warranty Expense in 2010
P 160,000
Where the provision being measured involves a large population of items, the obligation is estimated by
weighing all possible outcomes by their associated probabilities. The name for this statistical method of
estimation is ‘expected value’.
Question No. 2
Balance, 1/1/10 (P270,000 + 180,000)
P450,000
Amounts used in 2010
(200,000)
Increase in provision in 2010
230,000
Unused amounts reversed in 2010
(
70,000)
Balance, 12/31/10
P 410,000
Alternativee computation:
Alternativ
computation:
Increase in provision in 2010
Balance of provision from 2009 payable in 2011
Balance, 12/31/10
P230,000
180,000
P410,000
A provision shall be used
used only for expenditures
expenditures for which the
the provision
provision was originally
originally recognized.
recognized.
Provisions shall be reviewed at the end of each reporting period and adjusted to reflect the current best
estimate. If it is no longer probable that an outflow of resources embodying economic benefits will be
required to settle the obligation, the provision shall be reversed.
Question No. 3
Balance of provision from 2009 payable in 2011
P 180,000
Increase in provision in 2010
Minor defects
Major defects (P100,000 x 20%)
Provision for warranties – current
130,000
20,000
P 330,000
Question No. 4
Provision for warranties, 12/31/10
P410,000
Less current provision for warranties
330,000
Non-current provision
provision for warranties
warranties
P 80,000
Question No. 5
Provision for warranties, 12/31/10
P410,000
The other items should be treated as follows:
Expected overhaul – not a provision; Burdeos has no present obligation to conduct over haul. Rather, it is
evidence that the conveyer belt’s useful life has been shortened.
Unpaid amount of P700,000 (re peanut allergy case) – not a provision; there is no uncertainty regarding
timing or amount of settlement.
settlement. The amount should be included as part of trade and other payables.
Claim for damages against the entity’s advisers – contingent asset.
Guarantee – not a provision; although the entity has a present obligation under the guarantee; it is not
probable that an outflow
outflow of economic
economic benefits
benefits will be req
required
uired to settle
settle the obligation
obligation since Burgis
Burgis was in
a strong financial position at December 31, 2010. The guarantee would be disclosed as a contingent
liability.
Payable
PROBLEM NO. 7 – Bonds Payable
Gumaca Corporation authorized the sale of P2,000,000 of 12%, 10 year debentures on January 1, 2005.
Interest is payable on January 1 and July 1. The entire issue was sold on April 1, 2005, at 102 plus accrued
interest. On April 1, 2010, P1,000,000 of the bond issue was reacquired and retired at 99 plus accrued
interest. On June 30, 2010, the remaining bonds were reacquired at 97 plus accrued interest and refunded
with an issue of P1,600,000 of 9% bonds which were sold at 100.
QUESTIONS:
Based on the above and the result of your audit. Determine the following: ( Use straight line method to
amortize premium or discount)
1. Total cash receive from the sale of P2 million bonds on April 1, 2005
a. P2,100,000
c. P2,040,000
b. P2,000,000
P2,000,000
d. P2,120,000
P2,120,000
2. Interest expense for 2005
a. P180,000
c. P 157,241
b. P183, 077
d. P176,923
3. Carrying amount of bonds payable as of December 31, 2005
a. P2,037,241
c. P2,036,923
b. P2,042,759
d. P2,043,077
4. Gain or loss on retirement of P1 million bonds on April 1, 2010
a. P19,744 gain
c. P 256 gain
b. P19,744 loss
d. P19, 828 gain
5. Gain or loss on retirement of remaining bonds on June 30, 2010
a. P39,231 loss
c. P 20,679 gain
b. P39,231 gain
d. P39,310 gain
Answers: 1) A; 2) D; 3) C; 4) A; 5) B
Suggested Solution:
Question No. 1
Issue price (P2,000,000 x 1.02)
P2,040,000
Accrued interest (P2,000,000 x 12% x 3/12)
Total cash received from sale of bonds
60,000
P2,100,000
Question No. 2
Nominal interest
interest (P2,000,000
(P2,000,000 x 12% x 9/12)
9/12)
P180,000
Less premium amortization for 2005
(P40,000* x 9/117**)
Interest expense for 2005
3,077
P176,923
*(P2,000,000 x .02)
** 120 months (10 years) – 3 months (1/1/2005 to 4/1/2005)
Question No. 3
Carrying amount, 4/1/2005 (see no. 1)
P2,040,000
Less premium amortization
amortizatio n for 2005 (see no. 2)
Carrying amount, 12/31/2005
3,077
P2,036,923
Question No. 4
Face value of bonds retired
P1,000,000
Add unamortized bond premium,
(P40,000 x ½ x 57/117)
9,744
Carrying amount of bonds retired
1,009,744
Less retirement price (P1,000,000 x .99)
Gain on bond reacquisition
990,000
P
19,744
Question No. 5
Face value of bonds retired
P1,000,000
Add unamortized bond premium,
(P40,000 x ½ x 54/117)
9,231
Carrying amount of bonds retired
1,009,231
Less retirement price (P1,000,000 x .97)
Gain on bond reacquisition
970,000
P
39,231
PROBLEM NO. 8 – Bonds payable
In your initial audit of Infanta Finance Co., you find the following ledger account balances.
Debit
Credit
12%,25-year Bonds Payable, 2006 issue
01/01/2006
P6,400,000
Treasury Bonds
10/01/2010
P864,000
Bond Premium
01/01/2006
320,000
Bond Interest Expense
01/01/2010
384,000
07/01/2010
384,000
The bonds were redeemed for permanent cancellation on October 1, 2010 at 105 plus accrued interest.
QUESTIONS:
Based on the above and the result of your audit, determine the following: (Use
(Use straight line method to
amortize premium or discount)
a.
b.
a.
b.
a.
b.
a.
b.
1. The adjusted balance of bonds payable as of December 31, 2010 is
P5,536,000
c. P5,600,000
P6,400,000
d. P4,000,000
2. The unamortized bond premium on December 31, 2010 is
P320,000
c. P256,000
P224,000
d. P235,200
3. The total bond interest expense for the year 2010 is
P756,400
c. P731,600
P755,200
d. P731,200
4. The gain or loss on partial bond redemption is
P7,600 loss
c. P7,600 gain
P72,400 loss
d. P72,400 gain
Answers: 1)C; 2)B; 3)C; 4)A
Suggested Solution:
Question No. 1
Total bonds issued
Face value of bonds retired
P6,400,000
{P864,000/[1.05+(.12x3/12)]}
{P864,000/[1.05+(.12x3/12)]}
800,000
Adjusted balance of bonds payable, 12/31/10
P5,600,000
Question No. 2
Unamortized bond premium, 12/31/10
(P320,000 x 8/64 x 20/25)
P224,000
Question No. 3
Nominal interest:
interest:
Remaining bonds (P5,600,000 x 12%)
P672,000
Bonds retired (P800,000 x 12% x 9/12)
72,000
P744,000
Less premium amortization:
Remaining bonds (P320,000/25
(P320,000/2 5 x 14/16
11,200
Bonds retired (P320,000/25 x 2/16 x 9/12)
1,200
12,400
P731,600
Question No. 4
Face value of bonds redeemed
P800,000
Unamortized bond premium
(P320,000 x 8/64 x 20.25/25)
32,400
Carrying amount of bonds redeemed
832,400
Less retirement
retirement price (P800,000 x 1.05)
840,000
Loss on bond redemption
P 7,600
payable
PROBLEM NO. 9 – Bonds payable
In connection with the audit of the company’s financial statements for the year ended December 31, 2010,
the Lucban Corporation presented to you their records. This is the first time the company has been audited.
The company issued serial bonds on April 1, 2007. Your audit showed the following details of the issue
and the accounts as of December 31, 2010:
Total face value
P2,000,000
Date of bond
March 1, 2007
Total proceeds
P2,676,000
Interest rate
12% per annum
Interest payment date
March 1
Maturity dates and amount:
Date of maturity
Amount
March 1, 2010
P 500,000
March 1, 2011
P 500,000
March 1, 2012
P 500,000
March 1, 2013
P 500,000
P2,000,000
Since the corporation had excess cash, bonds of P500,000 schedule to be retired on March 1, 2012 were
retired on April 1, 2010. The total amount paid was charged to serial bonds payable amount.
Serial Bonds Payable
3/01/2010
VR
P500,000
4/01/2010
VR
P495,000
4/01/2007
CR
P2,656,000
GJ
P200,000
Accrued Interest Payable
01/01/2010
Interest Expense
3/01/2010
VR
P240,000
QUESTIONS:
Based on the information presented above and the result of your audit, answer the following: ( Use
bond outstanding method to amortize premium or discount)
1. The adjusted balance of the bonds payable account as of December 31, 2010 is
a. P2,000,000
c. P1,500,000
b. P1,084,000
d. P1,000,000
2. The unamortized bond premium as of December 31, 2010 should be
a. P66,642
c. P84,000
3. b.
The P82,444
accrued interest payable as of December 31, 2010d.isP104,000
a. P150,000
b. P120,000
c. P100,000
d. P200,000
4. The bond interest expenses that should be reported by the corporation for the year 2010 is
a. P55,264
b. P53,000
5. The gain on early retirement of bonds is
a. P79,000
b. P77,722
c. P63, 801
d. P59,611
c. P81,170
d. P
0
Answers: 1) D; 2) C; 3) C; 4) B; 5) A
Suggested Solution:
Question No. 1
Total bonds issued
P2,000,000
Bonds retired, 3/1/10
(500,000)
Bonds retired, 4/1/10
Adjusted balance of bonds payable, 12/31/10
(500,000)
P1,000,000
Question No. 2
Total proceeds
P2,656,000
Less accrued interest payable
(P2,000,000 x 12% x 1/12)
20,000
Issue price
2,636,000
Less face value
2,000,000
Total bond premium
636,000
Less:
Amortization:
Prior years (2007 to 2009)
P396,000
Current year (2010)
Bonds retired on maturity
(P500,000 x .006 x 2mos.)
P6,000
Bonds retired prior to maturity
(P500,000 x .006 x 3 mos.)
9,000
Remaining bonds
(P1M x .006 x 3 mos.)
72,000
87,000
483,000
Unamortized premium
Cancelled on bonds retired
Prior to maturity
(P500,000 x .006 x 23 mos)
69,000
Unamortized bond premium, 12/31/10
12/31/1 0
P84,000
Computation of amortization rate:
Year
Period Covered
Bond outs.
Mos.
Peso months
Premium amort*
2007
04/01-12/31
P2,000,000
9
P18,000,000
P108,000
2008
01/01/-12/31
2,000,000
12
24,000,000
144,000
2009
01/01-12/31
2,000,000
12
24,000,000
144,000
2010
01/01-02/28
2,000,000
2
4,000,000
24,000
03/01-12/31
1,500,000
10
15,000,000
90,000
01/01-02/28
1,500,000
2
3,000,000
18,000
03/01-12/31
1,000,000
10
10,000,000
60,000
01/01-02/28
1,000,000
2
2,000,000
12,000
03/01-12/31
500,000
10
5,000,000
30,000
01/01-02/28
500,000
2
1,000,000
6,000
2011
2012
2013
P106,000,000 P636,000
Amortization rate = P636,000/P106,0
P636,000/P106,000,000
00,000 = .006
.006
* Peso months x .006
Question No. 3
Accrued interest payable, 12/31/10
(P1,000,000 x 12% x 10/12)
Question No. 4
Nominal interest:
interest:
P100,000
Remainin
Remaining
g bonds (P1,000,000 x 12%)
P120,000
Bonds retired on maturity (P500,000 x 12% x 2/12
10,000
Bonds retired prior to maturity (P500,000 x 12% x 3/12)
15,000
145,000
Less premium amortization
amortizatio n for 2010 (see no. 2)
Interest expense for 2010
87,000
P 58,000
Question No. 5
Face value
Add unamortized bond premium, (P500,000 x .006 x 23 mos.)
P500,000
69,000
Carrying amount of bonds retired
569,000
Less retirement price (P500,000 x .98)
490,000
Gain on early retirement
retirement of bonds
P 79,000
Payable
PROBLEM NO. 10 – Bonds Payable
On January 1, 2009, Perez Corporation issued 5,000 of its 5-year, P1,000 face value, 11% bonds
dated January 1 at an effective annual interest rate (yield) of 9%. Interest is payable each
December 31. Perez uses the effective interest method of amortization. On December 31, 2010,
the 3,000 bonds were extinguished early through acquisition in the open market by Perez for
P2,970,000 plus accrued interest.
QUESTIONS:
Based on the above and the result of your audit, determine the following: ( Round off present
present
value factors to four decimal places.)
1. The issue price of the bonds on January 1, 2009 is
a. P5,388,835
c. P5,282,135
b. P4,630,655
d. P5,000,000
2. The carrying amount of the bonds on December 31, 2009 is
a. P4,755,930
c. P5,323,830
b. P5,453,840
d. P5,000,000
3. The gain on early retirement of bonds on December 31, 2010 is
a. P116,442
c. P181,785
b. P266,811
d. P
0
Answers: 1) A; 2) C; 3) C
Suggested Solution:
Question No. 1
PV of principal (P5,000,000 x 0.6499)
P3,249,500
PV of interest ([(P5,000,000
([(P5,000,000 x 11%) x 3.8897]
Issue price
2,139,335
P5,388,835
Question No. 2
Carrying amount, 1/1/06
P5,388,835
Less premium amortization for 2009:
Nominal interest
interest (P5M
(P5M x 11%)
Effective interest (P5,388,835 x 9%)
Carrying amount, 12/31/09
P550,000
484,995
65,005
P5,323,830
Alternativee Computation:
Alternativ
Computation:
PV of principal (P5M x 0.7084)
P3,542,000*
PV of interest [(P5M x 11%) x 3.2397]
1,781,835
Carrying amount, 12/31/09
P5,323,835
* P5 difference due to rounding off.
Question No. 3
Carrying amount, 1/1/09 (see no. 2)
P5,323,830
Less premium amortization for 2009:
Nominal interest
interest (P5M
(P5M x 11%)
Effective interest (P5,323,830
(P5,323,830 x 9%)
P550,000
479,145
70,855
Carrying amount, 12/31/10
P5,252,975
Carrying amount of bonds retired (P5,394,685 x 3/5
P3,151,785
Less retirement price
Gain early retirement of bonds
2,970,000
P 181,785
PROBLEM NO. 11 – Convertible bonds payable
On January 2, 2009, the Mauban Inc. issued P2,000,000 of 8% convertible bonds at par. The
bonds will mature on January 1, 2013 and interest is payable
payable annually every January
January 1. The
The bond
contract entitles the bondholders to receive 6, P100 par value, ordinary shares in exchange for
each P1,000 bond. On the date of issue, the prevailing market interest rate for similar debt
without the conversion option is 10%.
On January 1, 2013, the holders of the bonds with total face value of P1,000,000 exercised
exercised their
conversion privilege. On that date, the bonds were selling at 110 and the ordinary share at P42.
QUESTIONS:
Based on the above and the result of your audit, answer the following: (Round off present value
factors to 4 decimal places)
1. The proceeds from issuance of convertible bonds to be allocated to the liability component is
a. P1,366,000
c. P1,873,184
b. P1,778,336
d. P2,000,000
2. The proceeds from issuance of convertible bonds to be allocated to the equity component is
a. P634,000
c. P126,816
b. P221,664
d. P
0
3. The carrying amount of the bonds payable on December 31, 2009 is
a. P2,000,000
c. P1,389,400
b. P1,796,170
d. P1,900,502
4. The interest expense for the year 2010 is
a. P160,000
c. P138,940
b. P179,617
d. P190,050
5. The gain to be recognized on conversion of the bonds is
a. P126,816
b. P400,000
c. P463,408
d. P
0
Answers: 1) C; 2) C; 3) D; 4) D; 5) D
Suggested Solution:
Question No. 1
PV of principal (P2,000,000 x 0.6830)
PV of interest [(P2,000,000 x 8%) x 3.1699]
Liability component
P1,366,000
507,184
P1,873,184
PAS 32 par. 29 states that an entity
entity rec
recognized
ognized separately
separately the
the components
components of a financial
instrument that (a) creates a financial liability of the entity and (b) grants an option to the holder
of the instrument to convert it into an equity instrument of the entity. Par. 31 further states that
equity instruments are instruments that evidence a residual interest in the assets of an entity after
deducting all of its liabilities. Therefore, when an initial carrying amount of a compound
financial instrument is allocated to its equity
equity and liability
liability components,
components, the
the equity component is
is
assigned the residual amount after deducting from the fair value of the instrument as a whole the
amount separately determined for the liability component.
Question No. 2
Total proceeds
P2,000,000
Less liability component (see no. 1)
1,873,184
Equity component
P
126,816
Incidentally,
Incidental
ly, the journal
journal entry
entry to record
record the issuance
issuance of the convertible
convertible bonds
bonds follow:
Cash
P2,000,000
Discount on bonds payable
126,816
Bonds payable
P2,000,000
Share premium – conversion option
126,816
Question No. 3
Carrying amount, 1/2/09 (see no. 1)
P1,873,184
Add: Discount amortization for 2006:
Effective interest (P1,873,184 x 10%)
P187,318
Nominal interest
interest (P2,000,000
(P2,000,000 x 8 %)
160,000
Carrying amount, 12/31/09
27,318
P1,900,502
Question No. 4
Effective interest (P1,900,502 x 10%)
P190,050
Question No. 5
On conversion of a convertible instrument at maturity, the entity derecognizes the liability
component and recognized it as equity. The original equity component remains as equity
(although
it may beattransferred
from one
line item within equity to another). There is no ga
gain
in o
orr
maturity. (PAS
32 AG32)
loss on conversion
Journal entry to record the conversion (no transfer)
Bonds Payable
P1,000,000
Share Capital (P1,000,000/P1,000
(P1,000,00 0/P1,000 x 6 x P100)
P600,000
Share Premium – excess over par
400,000
Journal entry to record the conversion (with transfer)
Bonds Payable
Share Premium – conversion option (P126,816 x ½)
Share Capital (P1,000,000/P1,000
(P1,000,00 0/P1,000 x 6 x P100)
P1,000,000
63,408
P600,000
Share Premium – excess over par
463,408
The accounting for convertible bonds is similar in nature with accounting for bonds issued with
detachable warrants. Therefore, although both journal entries will have the same net effect on
equity, the second journal entry is preferable to be consistent with accounting for bonds with
detachable warrants.
PROBLEM NO. 12 – Convertible bonds payable
On January 1, 2005, Calauag Corporation issued a 10 per cent convertible bonds with a face value
of P4,000,000 maturing on December 31, 2014. Each P1,000 bond is convertible into ordinary
shares of Calauag at a conversion price of P25 per share. Interest is payable half-yearly in cash.
At the date of issue, Calauag could have issued nonconvertible debt with a ten-year term bearing
a coupon interest rate of 11 per cent.
On January 1, 2010, the convertible bond has a fair value of P4,400,000. Calauag makes a tender
offer to the holders to repurchase the bonds for P4,400,00. The holders of the P2,000,000 bonds
accepted the offer. At the fate of repurchase, Calauag could have issued non-convertible debt with
a five-year term bearing a coupon interest rate of 8 per cent.
On December 31, 2010, to induce the holders of the remaining bonds to convert the bonds
promptly, Calauag reduces the conversion
conversion price to P20 if the bonds are converted before March
March 1,
2011 (ie within 2 months). The market price of Calauag’s or dinary shares on the date the terms
are amended is P32 per share.
QUESTIONS:
Based on the above and the result of your audit, answer the following:
(Round off present
present value
value factors
factors to 4 decimal
decimal places)
places)
1. The proceeds from issuance of convertible bonds to be allocated to the equity component is
a. P235,520
c. P136,760
b. P239,120
d. P
0
2. The carrying amount of the bonds on December 31, 2009 is
a. P3,849,120
c. P3,113,180
b. P3,885,940
d. P4,000,000
3. The amount to be recognized
recognized in profit or loss as a result of the repurchase of the bonds on
January 1, 2010 is
a. P200,000
c. P180,400
b. P203,880
d. P237,730
4. The repurchase of the bonds on January 1, 2010 decreased equity by
a. P439,530
c. P76,630
b. P 37,710
d. P
0
5. The amount to be recognized in profit or loss as a result of the amendment of the terms on
December 31, 2010 is
a. P640,000
c. P64,000
b. P 10,000
d. P
0
Answers: 1)B; 2) A; 3)D; 4)B; 5)A
Suggested Solution:
Question No. 1
Issue Price
P4,000,000
Less Liability component:
PV of principal (P4,000,000 x 0.3427)
PV of interest [(P4,000,000
[(P4,000,00 0 x 5%) x 11.9504]
P1,370,800
2,390,080
Equity Component
3,760,000
P 239,120
Question No. 2
PV of principal (P4,000,000 x 0.5854)
P2,341,600
PV of interest [(P4,000,000
[(P4,000,000 x 5%) x 7.5376]
1,507,520
Carrying amount, 12/31/09
P3,849,120
Question No. 3
Carrying amount of bonds retired (P3,849,1
(P3,849,120
20 x ½)
P1,924,560
Less payment applied to liability component:
PV of principal (P2,000,000 x 0.6756)
PV of interest [(P2,000,000 x 5%) x 8.1109]
Loss on repurchase of bonds
P1,351,200
811,090
2,162,290
P
237,730
When an entity extinguishes a convertible instrument before maturity through an early
redemption or repurchase in which the original conversion privileges are unchanged, the entity
allocates the consideration paid and any transaction costs for the repurchase or redemption to
the liability and equity components of the instrument at the date of the transaction. The method
used in allocating the consideration paid and transaction costs to the separate components is
consistent with that used in the original allocation to the separate components of the proceeds
received by the entity when the convertible instrument was issued. ( PAS 32 AG33)
Once the allocation of the consideration is made, any resulting gain of loss is treated in
accordance with accounting principles applicable to the related component, as follows:
(a) The amount of gain or loss relating to the liability component is recognized in profit or loss;
and
(b) The amount of consideration relating to the equity component is recognized in equity. ( PAS
AG34)
Question No. 4
Retirement price (P4,4400,000 x ½)
P2,200,000
Less payment applied to liability component
Payment allocated to equity component
2,162,290
P
37,710
Question No. 5
Ordinary shares to issued – amended terms (P2,000,000/P20)
(P2,000,0 00/P20)
100,000
Ordinary shares to issued – original terms (P2,000,000/P25
(P2,000,000/P25
80,000
Incremental ordinary shares to be issued
20,000
Value of incremental shares to be issued (P20,000 x P32)
P640,000
An entity may amend the terms
terms of a convertible
convertible instrument
instrument to induce early
early conversion,
conversion, for
example by offering a more favorable conversion ratio or paying other additional consideration
in the event of conversion before a specified date. The difference, at the date the terms are
amended, between the fair value of the consideration the holder receives on conversion of the
instrument under the revised terms and the fair value of the consideration the holder would have
received under the original terms is recognized as a loss in profit or loss. ( PAS 32 AG35)
PROBLEM NO. 13 – Comprehensive
In connection with your audit of Pagbilao Corporation, you gathered the following liability and equity
account balances as of December 31, 2009:
1% bonds payable, at face value
Premium on bonds payable
Share Capital
P10,000,000
704,760
16,000,000
Share Premium
4,590,000
Retained Earnings
4,930,000
Treasury shares, at cost
650,000
Transactions during 2010 and other information relating to the Corporation’s liability and equity accounts
a ccounts
were as follows:
a) The bonds were issued on December 31, 2007, for P10,756,000 to yield 10%. The bonds mature on
Deecember 31, 2022. Interest in payable annually on December 31. The Corporation used the
effective interest method to amortize bond premium.
b) At December 31, 2009, the Corporation had 4,000,000, P10 par, authorized ordinary shares.
c) On January 15, 2010, the Corporation reissued 30,000 of its 50,000 treasury shares for 550,000. The
treasury shares had been acquired on February 28, 2009.
d) On November 2, 2010, the Cooperation borrowed P8,000,000 at 9% evidenced by a note payable to
ABC Bank. The note is payable in five equal annual principal installments of P1,600,000. The first
principal and interest
interest payment
payment is due on November
November 2, 2011.
e) On December 31, 2010, the Corporation owned 20,000 ordinary shares of Awoo Corp. which
represented a 1% ownership interest. Pagbilao accounts for this as availale for sale securities. The
shares were purchased on May 4, 2009 at P20 per share. The market price was P21 per share on
December 31, 2009, and P18 per share on December 31, 2010.
QUESTIONS:
Based on the above and the results of your audit, answer the following questions:
1. How much is the carrying of the bonds payable on December 31, 2010?
a. P10,675,236
c. P 9,324,764
b. P10,706,760
d. P10,654,360
2. How much is the treasury shares balance as of December 31, 2010?
a. P200,000
c. P260,000
b. P650,000
d. P100,000
3. How much is the noncurrent portion of the note payable to bank as of December 31, 2010?
a. P6,400,000
c. P8,000,000
b. P1,600,000
d. P
0
4. How much is the 2010 total interest expense?
a. P1,220,000
c. P1,249,524
b. P1,190,476
d. P1,187,236
5. How much is the net unrealized loss on available for sale securities as of December 31, 2010?
a. P60,000
c. P20,000
b. P40,000
d. P
0
Answers: 1)A; 2)C; 3)A; 4)B; 5)B
Suggested Solution:
Question No. 1
Carrying amount, 12/31/09 (P10,000,000
(P10,000,00 0 + P704,760)
P10,704,760
Less premium amortization for 2010:
Nominal interest
interest (P10,000,000
(P10,000,000 x 11%)
11%)
P1,100,000
Effective interest (P10,704,760 x 10%)
1,070,476
Carrying amount, 12/31/10
29,524
P10,675,236
Question No. 2
Treasury shares, 12/31/09
P650,000
Less cost of treasury shares issued (P650,000 x 3/5)
Treasury shares, 12/31/10
390,000
P260,000
Question No. 3
Total face value
Less principal installment
installment due, 11/1/11
P8,000,000
1,600,000
Noncurrent portion
portion
P6,400,000
Question No. 4
On note payable (8,000,000 x 9% x 2/12)
On bonds payable (see no. 1)
Total interest expense
P
120,000
1,070,476
P 1,190,476
Question No. 5
Cost (20,000 x P20)
P400,000
Market value (20,000 x P18)
360,000
Net unrealized
unrealized loss, 12/31/10
P 40,000
PROBLEM NO. 14 – Comprehensive
The noncurrent liabilities
liabilities of Pitogo Company at December
December 31, 2009 included the following:
following:
Note Payable,
Payable, bank
P3,600,000
Liability under finance lease
2,623,000
Note payable,
payable, supplier
supplier
1,500,000
Transactionss during 2010 and other information relating
Transaction
relating to Pitogo’s liabilities were as follows:
a) The note payable to the bank bears interest at 20% and is dated May 1,2009. The principal
amount of P3,600,000 is payable in four equal annual installments of P900,000 beginning May 1,
2010. The first principal and interest payment was made on May 1, 2010.
b) The finance lease is for a ten-year period. Equal annual payments of P750,000 are due on
December 31, of each year. The interest rate implicit in the lease is 18%. The amount of
P2,623,200 represents the present value of the six remaining lease payments (due December 31,
2010 through December 31, 2015) discounted at 18%.
c) The note payable to supplier bears interest at 19% and matures on September 30, 2011. On
February 25, 2011, after the end of
of the reporting period, but before the 2010 statements
statements were
authorized for issue, Pitogo Company consummated
consummated a noncancelable
noncancelable agreement with a lender to
refinance the 19%. P1,500,000 on a long term basis, on readily determinable terms that have not
yet been implemented. Both parties are financially capable of honoring the agreement, and there
have been no violations of the agreement’s provisions.
d) On April 1, 2010, Pitogo issued for P7,005,675, P6,000,000 face amount of its 20%, P100,000
bonds. The bonds were issued to yield
yield 15%. The bonds are dated April 1, 2010
2010 and mature
mature on
April 1, 2015. Interest is payable annually on April 1.
QUESTIONS:
Based on the above and the result of your audit, determine the following:
1. Liability under finance lease as of December 31, 2010
a. P1,873,200
c. P2,017,544
b. P2,345,376
d. P1,123,200
2. Carrying amount of bonds payable as of December 31, 2010
a. P6,893,813
c. P6,856,527
b. P7,417,536
d. P7,117,536
3. Total noncurrent liabilities as of December 31, 2010
a. P12,211,35
P12,211,357
7
c. P10,711,357
b. P10,154,19
P10,154,190
0
d. P 9,817,014
4. Current portion of long-term liabilities as of December 31, 2010
a. P3,150,000
c. P2,727,832
b. P2,812,824
d. P2,169,864
5. Total interest expense for the year 2010
a. P2,145,314
c. P1,673,139
b. P2,408,028
d. P1,673,139
Answers: 1)B; 2)A; 3)C; 4)C; 5)A
Suggested Solution:
Question No. 1
Liability under finance lease 1/1/10
P2,623,200
Less principal payment on 12/31/10
Total payment
Less applicable
applicable to interest (P2,623,200 x 18%)
Liability under finance lease, 12/31/10
P750,000
472,176
277,824
P2,345,376
Question No. 2
Carrying amount, 4/1/10
Less premium amortization:
P7,005,675
Nominal interest (P6,000,000 x 20% x 9/12)
P900,000
Effective interest (P7,005,675 x 15% x 9/12)
788,138
Carrying amount, 12/31/10
111,862
P6,893,813
Question No. 3
20% Note payable, bank
Balance, 12/31/10
(P3,600,000 – P900,000)
2,700,000
Less installment
installment due, 4/1/11
900,000
P1,800,000
Liability under finance lease:
Balance, 12/31/10 (see no. 1)
2,345,376
Less principal payment due on 12/31/11
Total payment
750,000
Less applicable to interest
(P2,345,376 x 18%)
422,168
327,832
2,017,544
20% bonds payable due 4/1/15 (see no. 2)
6,893,544
Total noncurrent liabilities, 12/31/10
P10,711,357
Question No. 4
20% note payable, bank - due 4/1/10
Finance lease liability – principal payment due on 12/31/10 (see no.3)
19% Note payable, bank – due 9/30/10
Current portion of long-term liabilities, ,12/31/09
P900,000
327,832
1,500,000
P2,727,832
The Note payable to supplier was classified as current liability since it is due within 12 months after the
reporting period and the entity does not have an unconditional right to defer settlement of the liability for
at least 12 months after the reporting period (even if an agreement to refinance on a long term basis is
completed after the end of the reporting period an before the financial statements are authorized for issue
– such an agreement would qualify for disclosure as a non-adjusting event in accordance with PAS 10).
Question No. 5
20% Note payable, bank
1/1 to 4/30 (P3,600,000 x 20% x 4/12)
5/1 to 12/31 (P2,700,000 x 20% x 8/12)
P240,000
360,000
P 600,000
Liability under finance lease (see no. 1)
472,176
20% bonds payable (see no. 2)
788,138
19% note payable, bank (P1,500,000 x 19%)
Total interest expense in 2010
285,000
P2,145,314
PROBLEM NO. 15 – Finance lease – Direct financing
Luna Corporation is in the business of leasing new sophisticated computer systems. As a lessor of
computers, Luna purchased a new system on December 31, 2009. The system was delivered the same day
(by prior arrangement) to General Investment Company, a lessee. The corporation accountant revealed
the following information relating to the lease transacti
transaction:
on:
Cost of system to Luna
P550,000
Estimated useful life and lease term
8 years
Expected residual value (unguaranteed)
(unguaranteed)
P40,000
Luna’ss implicit rate of interest
Luna’
12%
General’s incremental borrowing rate
14%
Date of first lease payment
December 31, 2009
Additional information is as follows:
(a) At the end of the lease, the system will revert to Luna.
(b) General is aware of Luna’s rate
ra te of implicit interest.
(c) The lease rental consists of equal annual payments.
QUESTIONS:
Based on the above and the result of your audit, answer the following: ( Round off present value
value factors
factors to
four decimal
decimal places.)
places.)
1. The annual lease payment under the lease is
a. P110,717
c. P102,665
b. P95,950
d. P91,664
2. The total financial revenue to be earned by the lessor over the lease
a. P257,600
c. P271,320
b. P52,714
d. P335,736
3. The interest income to be recognized by the lessor in 2010 is
a. P53,680
c. P54,486
b. P52,714
d. P52,547
4. The total expenses related to the lease that will be recognized by the lessee in 2010 is
a. P121,464
c. P112,630
b. P130,792
d. P119,276
5. The amount to be reported under current liabilities as liability under finance lease as of December
31, 2010 is
a. P60,239
c. P35,715
b. P48,611
d. P64,963
Answers: 1)B; 2)A; 3)C; 4)D; 5)B
Suggested Solution:
Question No. 1
Cost of system
P550,000
Less present value of unguaranteed residual value (P40,000 x 0.4039)
16,156
Net investment
investment to be recovered
533,844
Divide by the present value of annuity due of P1 at 12% for 8 periods
Annual lease payment
5.5638
P 95,950
Question No. 2
Gross investment in the lease:
Minimum lease payments (P95,950 x 8)
Unguaranteed residual value
P767,600
40,000
P807,600
Net investment
investment in the lease:
PV of minimum lease payments
PV of unguaranteed residual value
Total unearned interest income
533,844
16,156
550,000
P257,600
A lease is classified as a finance
finance lease if it transfers
transfers substantially
substantially all
all the risks
risks and rewards
rewards incidental
incidental to
ownership. A lease is classified as an operating lease if it does not transfer substantially all the risks and
rewards incidental to ownership. (PAS 17 par. 8)
Whether a lease is a finance lease or an operating lease depends on the substance of the transaction
rather than the form. Situations that would normally lead to a lease being classified as a finance lease
include the following:


The lease transfers ownership of the asset to the lessee by the end of the lease term;
The lessee has the option to purchase the asset at a price which is expected to be sufficiently
lower than fair value at the date the option becomes exercisable that, at the inception of the lease,
it is reasonably certain that the option will be exercised;



The lease term is for the major part of the economic life of the asset, even if title is not
transferred;
At the inception
inception of the lease,
lease, the preset
preset value of the minimum
minimum lease payments amounts
amounts to at least
least
substantially all of the fair value of the lea
leased
sed asset; and
The lease assets are of a specialized nature such that only the lessee can use them without major
modifications being made. (PAS 17 par. 10)
PAS 17 par. 4 defines
defines unearned finance income
income as the difference between:
between:
(a) The gross investment in the lease and
(b) The net investment in the lease
Gross investment in the lease is the aggregate of:
(a) The minimum lease payments receivable by the lessor under a finance lease, and
(b) Any unguar
unguaranteed
anteed residual
residual value accruing to the lessor.
lessor.
Net investment
investment in the lease is the gross
gross investment
investment in the
the lease d
discounted
iscounted at the interest
interest rate implicit
in the lease.
Question No. 3
Interest income in 2010 [(P550,000 – 95,950) x 12%]
P54,486
The following principles should be applied in the financial statements of lessors:



At commencement
commencement of the lease term, the
the lessor should
should record
record a finance
finance lease in the sta
statement
tement
of financial position as a receivable, at an amount equal to the net investment in the lease;
The lessor should recognize finance income based on a pattern reflecting a constant periodic
rate of return on the lessor’s net investment outstandin
outstanding
g in respect of the finance lease; and
For operating leases, the lease payment should be recognized
recognized as an expense
expense in the
the income
statement over
over the lease term
term on a straight-line
straight-line basis,
basis, unless
unless another systematic
systematic basis
basis is more
more
representative of the time pattern of the user’s benefit.
Question No. 4
Interest expense [(P533,844 – P95,950) x 12%]
Depreciation expense (P533,844/8)
(P533,844/ 8)
Total
P 52,547
66,731
P119,278
The following principles should be applied in the financial statements of lessees:

At commencement
commencement of the lease term, finance
finance leases
leases should be recorded
recorded as an asset and a liability
at the lower of the fair value of the asset and the present value of the minimum lease payments
(discounted at the interest rate implicit in the lease, if practicable, or else at the entity’s
incremental
increment
al borrowing rate);



Finance lease
lease payments should
should be apportioned between the finance charge and the reduction
reduction of
the outstanding liability (the finance charge to be allocated so as to produce a constant periodic
rate of interest on the remaining balance of the liability);
The depreciation policy for assets held under finance leases should be consistent with that for
owned assets. If there is no reasonable certainty that the lessee will obtain ownership at the nd of
the lease – the asset should be depreciated over the shorter of the lease term or the life of the
asset; and
For operating
operating leases, the lease payments should be recognize
recognized
d as an expense
expense in profit or loss
loss
over the lease term on a straight-line basis, unless another systematic basis is more
representative of the time pattern of the user’s benefit.
Question No. 5
Finance lease liability, 13/31/09
P533,844
Less lease payment, 12/31/09
95,950
Balance, 12/31/09
437,894
Less principal payment on 12/31/10;
Total payment in 2010
Less applicable
applicable to interest (P437,894 x 12%)
P95,950
52,547
43,404
Balance, 12/31/10
P394,491
Total payment in 2011
P95,950
Less applicable
applicable to interest (P394,491 x 12%)
Current portion of finance lease liability
47,339
P48,611
PROBLEM NO. 16 – Finance lease – direct financing
In connection with your audit Nakar Enterprises, you noted that the company has a long-standing
policy of acquiring
acquiring company
company equipment
equipment by leasing. Early in 2010,
2010, the company
company entered
entered into a lease
for a new milling machine. The lease stipulates that annual payments will be made for 5 years. The
payments are to be made in advance on December
December 31 of each
each year. At the end
end of the 5-year period,
Nakar may
may purchase the machine.
machine. The estimated
estimated economic
economic life of the
the equipment
equipment is 12 years.
years. Nakar
Nakar
uses the calendar year for reporting pusposes and straight-line depreciation for other equipment. In
addition, the following information about the lease is also available:
Annual lease payments (including executory costs of P5,000)
P60,000
Purchase option price
P25,000
Estimated fair value of machine after 5 years
P75,000
Implicit rate
Date of first lease payment
10%
Jan. 1, 2010
QUESTIONS:
Based
on the foregoing
and the
result of your audit, compute for the following: ( Round off present
present
value factors
to four decimal
places.)
1. Amount to be capitalized as an asset for the lease of the milling machine.
a. P229,345
c. P244,868
b. P224,017
d. P275,913
2. Liability under finance lease as of December 31, 2010
a. P130,919
c. P136,780
b. P153,855
d. P189,868
3. Amount to be reported under current liabilities as liability under finance lease as of December
31, 2010
a. P39,614
c. P41,908
b. P41,322
d. P36,013
4. Interest expense for the year 2010
a. P17,435
c. P16,902
b. P18,987
d. P
0
5. Depreciation expense for the year 2010
a. P20,406
c. P18,668
b. P19,112
d. P48,974
Answers: 1)C; 2)B; 3)A; 4)B; 5)A
Suggested solution:
Question No. 1
PV of rental payments (P55,000 x 4.1669)
PV of purchase option (P25,000 x 0.x6209)
PV of MLP (Cost of asset)
P229,345
15,523
P244,868
At the commencemen
commencementt of the lease term
term,, a lessee
lessee shall recognize
recognize finance
finance leases
leases as assets
assets and liabilities
liabilities in
its statement of financial position at amounts equal to the fair value of the leased property or, if lower, the
present value
value pf the
the minimum lease paym
payments,
ents, each
each determined
determined at the inception
inception of the lease. The
The discount
discount
rate to be used in calculating the present value of the minimum lease payments is the interest rate implicit
in the lease, if this is practicable
p racticable to determine; if not, the lessee’s incremen
incremental
tal borrowing rate shall be
used. (PAS 17 par. 20)
Minimum lease
lease payments
payments are payment
payment over the
the lease term that the lessee
lessee is or ccan
an be required
required to make,
make,
excluding contingent rent, costs for services and taxes to be paid by and reimbursed to the lessor,
together with:
(a) For a lessee,
lessee, any amounts guaranteed
guaranteed by the lessee
lessee or by a party related
related to the
the lessee;
lessee; or
(b) For a lessor,
lessor, any residual
residual value
value guaranteed
guaranteed to the lessor by
by::
i.
ii.
iii.
The lessee;
A party related
related to the
the lesse
lessee;
e; or
A third party
party unrelated
unrelated to the lessor tha
thatt is financially
financially capable
capable of discharging
discharging the
the
obligation under the guarantee.
However, if the lessee
lessee has an
an option to purchase
purchase tthe
he asset at
at a price that is expected
expected to be sufficiently
sufficiently
lower than the fair value at the date the option becomes exercisable for it to be reasonably certain, at the
inception of the lease, that the option will be exercised, the minimum lease payments comprise the
minimum payments payable over the lease term to the expected date of exercise of this purchase option
and the payment required to exercise it.
Question No. 2
Finance lease liability, 1/1/10
P244,868
Less lease payment, 1/1/10
55,000
Balance, 1/1/10
189,868
Less principal payment on 12/31/10:
Total payment in 2010
Less applicable to interest (P189,868 x 10%)
Balance, 12/31/10
P55,000
18,987
36,013
P153,855
Question No. 3
Rental payment in 2011
Less applicable
applicable to interest (P153,855 x 10%)
Current portion of finance lease liability
P55,000
15,386
P39,614
Question No. 4
Interest Expense in 2010 (see no. 2)
P18,987
Question No. 5
Depreciation expense in 2010 (P244,868 / 12)
P20,406
PROBLEM NO. 17 – Finance lease – Sales type
Catanauan Incorporated uses leases as a method of selling its products. In early 2009, Catanauan
completed construction of a passenger ferry for use between Quiapo and Guadalupe. On April 1, 2009,
the ferry was leased to the Balik-Balik Ferry line on a contract specifying that ownership of the ferry will
transfer to the lessee at the end of the lease period. The ferry is expected to be economically useful for 25
years. Annual lease payments do not include executory costs. Other terms of the agreement are as
follows:
Original cost of the ferry
P1,500,000
Lease payments
P 225,000
Estimated residual value
P
78,000
Implicit rate
10%
Date of first lease payment
April 1, 2009
Lease period
1 year
PV of an ordinary annuity of 1 for 20 periods 10%
8.5136
PV of an annuity due of 1 for 20 periods at 10%
9.3649
PV of 1 for 20 periods at 10%
0.1486
QUESTIONS:
Based on the above and the result of your audit, determine the following:
1. Total finance income that will be earned by the lessor over the lease term.
a. P2,459,306
c. P2,392,897
b. P2,650,849
d. P2,584,440
2. The profit on sale to be recognized by the lessor
a. P607,103
c. P415,560
b. P427,151
d. P618,694
3. Liability under finance lease to be reported by the lease as of December 31, 2010
a. P1,634,616
c. P1,858,063
b. P1,845,313
d. P1,647,366
4. Amount to be reported under current liabilities as liability under finance lease by the lessee as of
December 31, 2010
a. P61,538
c. P40,469
b. P39,194
d. P60,263
5. Depreciation expense to be recognized by the lessee for the year 2009
a. P61,221
c. P76,091
b. P55,127
d. P60,873
Answers: 1)C; 2)A; 3)B; 4)C; 5)D
Suggested Solution:
Question No. 1
Gross investment in the lease (P225,000 x 20)
Net investment
investment in the lease (P225,000 x 9.3649)
P4,500,000
2,107,103
Total finance income
P2,392,103
The unguaranteed residual value was not included in the computation of the minimum lease payments
since the leased asset
asset will be not revert
revert to the lessor.
Question No. 2
Sales (PV of MLP)
Less cost of sales
Profit on sale
P2,107,103
1,500,000
P 607,103
Question No. 3
Finance lease liability, 4/1/09
P2,107,103
Less lease payment, 4/1/09
225,000
Balance, 4/1/09
1,882,103
Less principal payment on 4/1/10:
Total payment in 2010
Less applicable
applicable to interest (P1,882,103 x 10%)
P225,000
188,210
Balance, 12/31/10
36,790
P1,845,313
Question No. 4
Rental payment in 2011
Less applicable to interest (P1,845,313
(P1,845,31 3 x 10%)
Current portion of finance lease liability
P250,000
184,531
P 40,469
Question No. 5
Depreciation expense in 2009 [(P2,107,103 – P78,000) x 1/25 x 9/12]
P60,873
PROBLEM NO. 18 – Finance lease – Sales type
Real Inc. leases equipment to its customers under noncancelable leases. On January 1, 2010.Real
leased equipment costing P4,000,000 to Quezon Co., for nine years. The rental cost was P440,000
payable in advance semiannually (January 1 and July 1), plus P20,000 semiannually for executory
costs. The equipment had an estimated life of 15 years and sold for P5,330,250 with an estimated
unguaranteed residual value of P800,000. The implicit interest rate is 12 percent.
QUESTIONS:
Based on the foregoing and the result of your audit, compute for the following:
following: (Round off present
value factors to four decimal places.)
1.How much is the total interest income from lease that will be earned by Real Inc.?
a.
P2,869,988
c. P3,675,616
b. P3,389,748
d.
0
2.Real, Inc. should report profit on the sale at
a.
P1,330,252
c. P1,050,012
b. P1,044,384
d. P1,338,492
3.How much should be reported by Quezon Co. as liability under finance lease as of December
31, 2010?
a.
P4,143,593
c. P4,273,410
b.
P4,446,613
d. P
0
4.How much should be reported by Quezon Co. under current liabilities as liability under finance
lease as of December 31, 2010?
a.
P356,798
c.
b. P378,207
P394,252
d. P
0
5.How much interest expense should be reported by Quezon Co. in relation to the lease for the
year ended December 31,2010?
a.
P508,064
c. P543,398
b. P501,793
Answers: 1) B;
d.
2)A;
3)B;
4)A;
5)C
Suggested Solution:
Question No.1
Gross investment in the lease :
Minimum lease payments
(P440,000 x 18)
P7,920,000
0
Unguaranteed residual value
Net Investment in the lease:
800,000
P8,720,000
PV of minimum lease payments
(440,000 x 11.4773)
5,050,012
PV of unguaranteed residual value
(800,000 x 0.3503)
280,240
Total unearned interest income
_5,330,252
P3,389,748
Question No.2
Sales (present value MLP)
P5,050,012
Less cost of sales (4,000,000 – P280,240)
__3,719,760
Profit on Sale
P1,330,252
Question No.3
Finance lease liability (440,000 x 11.4773)
P5,050,012
Less lease payment, 1/1/10
440,000
Balance,1/1/10
4,610,012
Less principal payment on 7/1/10:
Total payment
P440,000
Applicable to interest
(P4,610,012 x 12% x 6/12)
276,601
Balance, 12/31/10
__163,399
P4,446,613
The lease shall be accounted for as finance lease because the present value of the minimum lease
payments amount to substantially all of the fair value of the leased asset at the inception of the
lease (P5,050,012/P5,330,250 = 95%).
Question No.4
Principal payment due, 1/1/11:
Total payment
P440,000
Applicable to interest
(4,446,613x 12% x 6/12)
266,797
P173,203
Principal payment due, 7/1/11
Total payment
440,000
Applicable to interest
[(P4,446,613 – P173,203) x 12% x 6/12]
256,405
183,595
Current portion of finance lease liability, 12/31/10
P356,798
Question No. 5
1/1/10 to 6/30/10 (P4,610,012 x 12% x 6/12)
P276,601
7/1/10 to 12/31/10 (P4,446,613 x 12% x 6/12)
266,797
Total interest expense
P543,398
PROBLEM NO. 19 – Sale and lease back
Guihayangan
purchase
land
andconstruction
constructs aisservice
station
car and
wash
forona which
total of
P6,750,000.AtCo.
January
2,2010,
when
completed,
the and
facility
land
it
was constructed are sold to a major oil company for P7,500,000 and immediately leased from the
oil company by Guinayangan. Fair value of the land at time of the sale was P75
P750,000.
0,000. The lease is
a 10-year,noncancelable lease. The agreement requires equal rental payments at the end of each
year beginning December 31,2010. The interest rate implicit in the lease is 10%. Guinayangan
uses straight-line depreciation for its other various business holdings. The economic life of the
facility is 15 years with zero salvage value. Title to the facility and land will pass to Guinayangan
at termination of the lease.
QUESTIONS:
Based on the above and the result of your audit, answer the following:
(Round off present value factors to four decimal places)
1.The amount of annual lease payment is
a.
P1,098,526
c. P 976,467
b. P1,220,584
d. P1,109,632
2.The total lease-related expenses to be recognized by the lessee during 2010 is
a.
P1,000,000
c. P1,075,000
b. P1,425,000
d. P1,200,000
3. The total lease-related income to be recognized by the lessee during 2010 is
a. P75,000
c. P750,000
b. P50,000
d. P
0
4. The total lease-related income to be recognized by the lessor during 2010 is
a.
P675,000
c. P750,000
b. P600,000
d. P
0
5.The amount to be reported under current liabilities as liability under finance lease as of
December 31,2010 is
a.
P517,642
c. P414,114
b. P470,595
d. P465,879
Answers: 1)B;
2)D;
3)A;
4)C;
5)A
Suggested Solution:
Question No. 1
Cost of facility (purchase price)
P7,500,000
Divide by (PV of ordinary annuity of P1 at
10% for 10 periods)
Annual lease payment
6.1446
P1,220,584
Question No. 2
Interest expense (P7,500,000 x 10%)
P 750,000
Depreciation Expense
(P7,500,000-P750,000/15)
Total
450,000
P1,200,000
Question No. 3
Selling price
Less cost of facility
Gain on sale and leaseback
Divide by lease term
P7,500,000
6,750,000
750,000
10
Gain to be recognized in 2010
P
75,000
If a sale and leaseback transaction results in a finance lease, any
an y excess
e xcess of sales proceeds over
the carrying amount shall not be immediately recognized as income by a seller-lessee. Instead, it
shall be deferred and amortized over the lease term.(PAS 17 par. 59)
Question No. 4
Interest income in 2010 (P7,500,000 x 10%)
P750,000
Question No. 5
Finace lease liability, 1/2/10
P7,500,000
Less principal payment on 12/31/10:
Total payment in 2010
P1,220,584
Less applicable to interest
(P7,500,000 x 10%)
750,000
___470,584
Balance, 12/31/10
P7,029,416
Rental payment in 2011
P1,220,584
Less applicable to interest (P7,029,416 x 10%)
702,942
Current portion of finance lease liability
P 517,642
PROBLEM NO. 20 – Pension
The following information relates to the defined benefit pension plan of the Tiaong Company
Compan y as
of January 1,2009:
Projected benefit obligation (PBO)
P16,150,000
Fair value of plan assets
15,135,000
Unrecognized prior service cost
1,050,000
Unrecognized actuarial gain or loss
0
Pension data for the years 2009 and 2010 follows:
2009
2010
Current service cost
P 870,000
P1,150,000
Contribution to the plan
1,200,000
1,250,000
Benefits paid to retirees
1,320,000
1,400,000
Actual return on plan assets
263,500
1,800,000
Amortization of past service cost
Actuarial change increasing PBO
210,000
800,000
186,667
-
Settlement interest rate
11%
11%
10%
10%
Long-term expected rate of return on
Plan assets
As of January 1,2010,the remaining expected service life of employee was 5 years.
QUESTIONS:
Based on the above result of your audit, answer the following:
1.What is the 2009 net pension expense?
a.
P2,593,000
c. P1,200,000
b. P4,370,000
d. P1,343,000
2.The projected benefit obligation as of December 31,2009 is
a.
P18,276,500
c. P17,476,500
b. P16,973,000
d. P16,173,000
3.The prepaid/accrued pension expense on December 31,2009 is
a.
P1,358,000
b. P3,153,000
c. P108,000
d. P
0
4.What is the 2010 net pension expense?
a.
P1,863,702
c. P1,547,082
b. P1,250,000
d. P1,819,232
5.The prepaid/accrued pension expense on December 31,2010 is
a.
P 0
b. P3,143,302
c. P1,655,082
d. P 721,702
Answers:1)D;
2)A;
3)C;
4)A;
5)D
Suggested Solution:
Question No. 1
Current Service Cost
Interest cost (P16,150,000 x 11%)
Expected return on plan assets (P15,135,000 x 10%)
Amortization of past service cost
Net pension expense
P
870,000
1,776,500
(1,513,500)
210,000
P 1,343,000
The entity shall recognize the net total of
o f the following amounts in profit or loss:







current service cost;
interest expense;
expected return on plan assets;
actuarial gains and losses, as required in accordance with the entity’s accounting policy;
past service cost, to the extent recognized
effect of any plan curtailments or settlements; and
the effect of the limit in paragraph 58(b) of PAS 19,unless recognized ou
outside
tside profit or loss.
Current service cost is the increase in the present value of the defined benefit obligation
resulting from employee service in the current period.
Interest cost is the increase
increase during a period
period in the present value of a defined benefit obligation
which arises because the benefits are one period closer to settlement.
The return on plan assets is interest, dividends and other revenue derived from the plan assets,
together with realized and unrealized gains or losses on the plan assets, less any cost of
administering the plan and less any tax payable by the plan itself.
Plan assets comprise:
(a) assets held by a long-term employee benefit fund; and
(b) qualifying insurance policies.
Assets held by a long-term employee benefit fund are assets (other than
than nontransferable financial
instruments issued by the reporting entity) that:
(a) are held by an entity (a fund) that is legally separate from the reporting entity and
exists solely to pay or fund employee benefits; and
(b) are available to be used only to pay or fund employee benefits, are not available to the
reporting entity’s own creditors (even in bankruptcy), and cannot be returned to the
reporting entity, unless either:
(i)the remaining assets of the fund are sufficient to meet all the related employee benefit
obligations of the plan or the reporting entity; or
(ii) the assets are returned to the reporting entity to reimburse it for employee benefits
already paid.
A qualifying insurance policy is an insurance policy issued by an insurer that is not a related party
(as defined in PAS 24 Related
Related Party Disclosures) of the reporting entity, if the proceeds of the
policy:
(a) are
can be
only totopay
fund employee
benefits
under a defined
benefit
plan; and
(b)
notused
available
theorreporting
entity’s
own creditors
(even in
bankruptcy)
and
cannot be paid to the
th e reporting entity, unless either;
(i)the proceeds represent surplus assets that are not needed for the policy to meet all
the related employee benefit obligations; or
(ii)the proceeds are returned to the reporting entity to reimburse it for employee benefit
already paid.
Actuarial gains and losses comprise:
(a) experience adjustments (the effects of differences between the previous actuarial
assumptions and what has actually occurred); and
(b) the effects of changes in actuarial assumptions
PAS 19 specifies that if the accumulated unrecognized actuarial gains and losses exceedn10% of
the greater of the defined benefit obligation or the fair value of plan assets, a portion of that net
gain or loss is required to be recognized in accordance with the entity’s accounting policy.
policy . The
portion recognized is the excess divided by the expected average
a verage remaining working lives of the
participating employees. Actuarial gains and losses that do not breach the 10% limits described
d escribed
above (the ’corridor’) need not to be recognized – although the enterprise may choose to do so.
Past service cost
cost is the increase in the present
present value of the defined benefit obligation for employee
service in prior periods, resulting in the current period from the introduction of, or changes to,
post-employment benefits
ben efits or other long-term employee benefits.
b enefits. Past
Pa st service cost may be either
positive (where benefits are introduced or imposed) or negative (where existing benefits are
reduced).
Past service
service cost should be recognized immediately
immediately to the extent that it relates to former employees
or to active employees already vested (i.e. not conditional on future employment). Otherwise, it
should be amortized on a straight-line basis over the average period until the amended benefits
become vested.
A curtailment occurs when an entity either:
(a) is demonstrably committed to make a material reduction in the number of employees
covered by a plan; or
(b) amends the terms of a defined benefit plan such that a material element of future service
by current employees will no longer qualify for benefits, or will qualify only for reduced
benefits.
A settlement occurs
o ccurs when an entity enters into a transaction that eliminates all further legal or
constructive obligation for part or all of the benefits provided under a defined benefit plan, for
example, when a lump-sum cash payment is made
mad e to, or on behalf of, plan participants in exchang
exchangee
for their rights to receive specified post-employment benefits.
An entity shall recognize gains or losses
losses on the curtailment or set
settlement
tlement of a defined benefit plan
when the curtailment or settlement occurs. The gain or loss on a curtailment or settlement shall
comprise (a) any resulting change in the present value of the defined benefit obligation; (b) any
resulting change in the fair value of the plan assets; (c) any related actuarial gains and losses and
past service cost that had not previously been recognized.
Question No. 2
Projected benefit obligation, 1/1/09
Current service cost
Interest cost (P16,150,000 x 11%)
Actuarial change increasing PBO
Benefits paid to retirees
Projected benefit obligation
P16,150,000
870,000
1,776,500
800,000
(1,320,000)
P18,276,500
Question No. 3
Debits
Fair value of plan assets, 12/31/09
Fair value of plan assets, 1/1/09
Contribution to the plan
Actuarial return on plan assets
Benefits paid to retirees
P15,135,000
1,200,000
263,500
(1,320,000)
P15,278,500
Unrecognized prior service cost,
12/31/09 (P1,050,000 – P210,000)
840,000
Unrecognized actuarial loss, 12/31/09
Difference between expected and actual
return on plan assets (P1,513,500 – P263,500)
Actuarial change increasing PBO
1,250,000
800,000
2,050,000
18,168,5000
Credit
Projected benefit obligation, 12/31/09 (see no. 2)
18,276,500
Prepaid (Accrued) pension expense, 12/31/09
(P108,000)
Alternative Computations:
Debits
Fair value of plan assets, 1/1/09
P15,135,000
Unrecognized prior service cost, 1/1/09
1,050,000
16,185,000
Credit
Projected benefit obligation, 1/1/09
P16,150,000
Prepaid (Accrued) pension cost, 1/1/09
P
35,000
Prepaid (Accrued) pension cost, 1/1/09
P
35,000
Underfunding in 2009:
Contributions to the plan
Net pension expense(see no.1)
P1,200,000
1,343,000
Prepaid (Accrued) pension expense, 12/31/09
(143,000)
(P108,000)
Question No. 4
Current service cost
P1,150,000
Interest cost (P18,276,599 x 11%)
2,010,415
Expected return on plan assets
(P15,278,500 x 10%)
(1,527,850)
Amortization of past service cost
186,667
Amortization of unrecognized net actuarial loss:
Unrecognized net actuarial loss 1/1/10
Less corridor (P18,276,500 x 10%)
Excess
Divide by remaining service life
Prepaid (Accrued) pension expense, 12/31/10
PROBLEM NO. 21 – Pension
P2,050,000
1,827,650
222,350
5
(613,702)
(P721,702)
You gathered the following information related to Jomalig
J omalig Company’s the defined benefit plan
for the year ended December 31,2010:








Current service cost of providing benefits for the year to December
Decembe r 31,2010: P54 million
Average remaining working life of employees: 10 years
Benefits paid to retired employees in the year: P55.8
P5 5.8 million
Contribution paid to fund: P37.8 million
Present value of obligation to provide benefits: P3,960 million at January 1,2010, and
P4,500 million at December 31,2010
Net cumulative unrecognized gains at January 1, 2010: P453.6 million
Past service cost: P207 million. All of these benefits have vested.
Discount rates and expected rates of return on plan assets:
1/1/10
1/1/11
Discount rate
5%
6%
Expected rate of return on plan assets
7%
8%
QUESTIONS:
Based on the above and the result of your audit, answer the following:
1.The amount to be recognized in the statement of the financial position as of January 1, 2010 is
a.
P633.3 million
c. P957.6 million
b.
P453.6 million
d. P455.4 million
2.The amount of actuarial gain to be recognized in profit or loss for the year ended December
31,2010 is
a.
P7.20 million
c. P3.60 million
b.
P5.76 million
d. P
0
3.The net pension expense to be recognized in profit or loss for the year ended December
31,2010 is
a.
P188.64 million
c. P3.60 million
b.
P183.60 million
d. P270.00million
4.The unrecognized actuarial gain as of December 31,2010 is
a.
P448.2 million
c. P604.44 million
b.
P453.6 million
d. P
0
5.The amount to be recognized in the statement of financial position as of December 31,2010 is
a.
P784.44 million
c. P180.00 million
b.
P682.20 million
d. P455.40 million
Answers: 1)A;
2)B;
3)A;
4)C;
5)A
Suggested Solution:
Question No. 1
Debit
Fair value of plan assets, 1/1/10
Credits
Present value of obligation, 1/1/10
Net cumulative unrecognized gains, 1/1/10
Prepaid (Accrued) pension expense, 1/1/10
P3,870.0
P3,960.0
453.6
4,413.60
(P633.6)
Question No. 2
Net cumulative unrecognized gains, 1/1/10
Less corridor (3,960 million x 10%)
Excess
Divide by average remaining working life of employees
Amount to be recognized in profit or loss
453.6
396.00
57.6
10
P 5.76
Question No. 3
Current service
cost
Interest cost (P3,960 million x 5%)
Expected return on plan assets (P3,780 million x 7%)
Past service cost
Actuarial gain recognized (see no.2)
Net pension expense
P54.00
198.00
(264.60)
207
(5.76)
P188.64
Question No. 4
Net cumulative unrecognized gains, 1/1/10
Actuarial loss on obligation (see computation)
Actuarial gain on plan assets (see computation)
Actuarial gain recognized (see no.2)
453.60
(136.80
293.40
(5.76)
Net cumulative unrecognized gains, 12/31/10
P604.44
Actuarial loss on obligation
Present value of obligation, 1/1/10
Current service
cost
Interest cost (P3,960 million x 5%)
Past service cost
Benefits paid
Actuarial loss on obligation (squeeze)
Present value of obligation, 12/31/10
Actuarial gain on plan assets
Fair value of plan assets, 1/1/10
Expected return on plan assets (P3,780 million x 7%)
Contribution to the plan
Benefits paid to retirees
Actuarial gain on plan assets (squeeze)
Fair value of plan assets, 12/31/10
P3,960.00
54.00
198.00
207.00
(55.80)
136.80
P4,500.00
P3,780.00
264.60
37.80
(55.80)
293.40
P4,320
Question No. 5
Debit
Fair value of plan assets, 12/31/10
Credits
Present value of obligation, 12/31/10
Net cumulative unrecognized gains, 12/31/10
Prepaid (Accrued) pension expense, 12/31/10
P4,320.00
P4,500.00
P604.44
5,104.44
(P784.44)
PROBLEM NO. 22 – Pension
The following information relates to the defined benefit pension plan of the Lopez Corporation
for the year ended December 31,2010:
Projected benefit obligation, January 1
Projected benefit obligation, December 31
Fair value of plan assets, January 1
Fair value of plan assets, December 31
P13,800,000
13,150,000
11,500,000
13,600,000
Unrecognized past service cost, January 1
Unrecognized net actuarial loss, January 1
Contribution to the plan
Benefits paid to retirees
Amortization of past service cost
Actuarial change decreasing PBO
Present value of available refunds and reductions
in future contribution to the plan
Expected return on plan
assets
Settlement
rate
Expected average remaining working lives of the
employees participating in the plan
500,000
1,300,000
2,000,000
1,800,000
100,000
906,000
250,000
14%
12%
10 years
QUESTIONS:
Based on the above and the result of your audit, determine the following:
1.Current service cost for 2010
a.
P400,000
b. P1,778,000
c. P506,000
d. P650,000
2.Actual return on plan assets in 2010
a.
P100,000
b. P1,610,000
c. P1,900,000
d. P2,100,000
3.Unrecognized net actuarial loss as of December 31,2010
a.
P104,000
b. P96,000
c. P1,904,000
d. P1,010,000
4.Amount to be recognized in the statement of financial position as of December 31,2010
a.
P650,000
c. P954,000
b. P754,000
d. P504,000
5.Net amount to be recognized in 2010 profit or loss
a.
P761,000
c. P996,000
b. P546,000
d. P746,000
Answers: 1)A;
2)C;
3)A;
3)A;
4)B,
5)D
Suggested Solution:
Question No. 1
Projected benefit obligation, January 1,2010
Current service cost (squeeze)
Interest cost (P13,800,000 x 12 %)
Actuarial change decreasing PBO
Benefits paid to retirees
Projected benefit obligation, December 31,2010
P13,800,000
400,000
1,656,000
(906,000)
(1,800,000)
P13,150,000
Question No. 2
Fair value of plan assets, January 1
,2010
Actual return on plan assets (squeeze)
Contribution to the plan
Benefits paid to retirees
Fair value of plan assets, December 31,2010
P11,500,000
1,900,000
2,000,000
(1,800,000)
P13,600,000
Question No. 3
Unrecognized net actuarial loss, January 1,2010
Actuarial change
decreasing PBO
Difference between actual and expevted return on plan assets
[P1,900,000 - (P11,500,000
x 14%)]
Unrecognized net actuarial loss, December 31,2010
1,300,000
(906,000)
(290,000)
P104,000
Question No. 4
Debits
Fair value of plan assets,12/31/10
Unrecognized past service cost,
12/31/10
(P500,000 - P100,000)
Unrecognized net actuarial loss,
12/31/10
Credit
P13,600,000
400,000
P104,000
P14,104,000
Present value of obligation, 12/31/10
Prepaid (Accrued) pension expense, 1/1/10
P13,150,000
P954,000
The amount recognized as a defined benefit liability shall be the net total of the following amounts:
(PAS 19 par. 54)
(a)
(b)
(c)
(d)
The present value of the defined benefit obligation at the end of the reposting period;
Plus any actuarial gains (less any actuarial losses) not recognized;
Minus any past services cost not yet recognized;
Minus the fair value at the end of the reporting period of plan assets (if any) out of which
the obligations are to be settled directly.
If the calculation of the statement of the financial position amount as set out above results in
an asset, the amount recognized should be limited to the net total of unrecognized actuarial
losses and past service cost, plus the present value of available
a vailable refunds and reductions in future
contributions to the plan (PAS 19 par.58).
The asset ceiling is computed below:
Unrecognized net actuarial loss
Unrecognized past service cost
Present value of available refunds and reductions in future contributions to the plan
Limit on the amount that may be recognized as asset
Since the amount computed based on PAS 19 par 58b is lower than the amount computed based
on PAS 19 par. 54, the amount to be recognized in the statement of financial position should be
limited to P754,000. The excess of P200,000 is recognized in accordance with the entity’s
accounting policy (i.e. either within or outside
ou tside profit or loss).
Question No. 5
Current service cost (see no. 1)
Interest cost (P13,800,000 x 12 %)
P400,000
1,656,000
Expected return on plan assets P11,500,000 x 14%)
Actuarial loss recognized (see below)
Past service cost amortization
Excess over limit on recognized asset (see no. 4)
Net pension expense
(1,610,000)
0
100,000
200,000
P746,000
Unrecognized net actuarial loss, 1/1/10
Less corridor (P13,800,000)
Excess
P1,300,000
1,380,000
P
0
PROBLEM NO. 23 – Debt restructuring
On December 31,2010, Maca Company
Compan y was indebted to Lelon Co. onyaears P2,000,000,10% no
note.
te.
Only interest had been paid to date.Due to its financial difficulties Maca Company has negotiated
a restructuring of its note payable. The parties agreed that Maca Company would settle the debt
on the following terms:
Settle one-half of the note by transferring land with a recorded value of P800,000 and fair
value of P900,000.
Settle one-fourth of the note by transferring 200,000 shares of P1 par ordinary shares with
a fair market value of P15 per share.
Modify the terms of the remaining one-fourth of the note by reducing the interest rate to
5%, extend the due date three years from the date of restructuring and reducing the principal
to P300,000.


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QUESTIONS:
Based on the above and the result of your audit, determine the following:
1.Gain on extinguishment of debt on the P1million note
a.
P300,000
c. P100,000
b. P200,000
d. P
0
2.Share premium to be recognized on the settlement of P500,000 note by issuing ordinary shares
a.
P2,500,000
c. P2,300,000
b. P300,000
d. P
0
3.Total gain on extinguishment of debt
a.
P437,306
c. P550,006
b. P337,306
d. P
0
4.Interest expense in 2011
a.
P15,000
c. P7,500
b. P26,269
d. P13,134
5.Carrying amount of the note payable as of December 31,2011
a.
P273,963
c. P142,494
b. P262,694
d. P300,000
Answers:1)B;
2)B;
3)A;
4)B,
5)A
Suggested Solution:
Question No. 1
Carrying amount of liability (P2,000,000 x 1/2)
P1,000,000
Less carrying amount of land
Gain on extinguishment of debt
800,000
P200,000
Question No. 2
Carrying amount of liability (P2,000,000 x 1/4)
Less par value shares issued (200,000 x 1)
Share premium
P500,000
200,000
P300,000
Question No. 3
Modification of terms:
Carrying amount of liability (P2,000,000 x 1/4)
Less present value of restructured debt:
Principal (P300,000 x 0.7513)
Interest (P300,000 x 5% x 2.4869)
Gain on extinguishment of debt
Asset swap (see no. 1)
Total gain on extinguishemnt debt
P500,000
P225,390
__37,304
262,694
237,306
200,000
P437,306
An entity shall remove a financial liability (or a part of a financial liability) from its statement of
financial position when, and only when, it is extinguished ie when the obligation specified in the
contract is discharged or cancelled or expires. (PAS 39 par 39)
An exchange between an existing borrower and lender of debt instruments with substantially
different terms shall be accounted for as an extinguishment of the original financial liability and
the recognition of a new financial liability. Similarly, a substantial modification of the terms of an
existing financial liability or a part of it (whether or not attributable to the financial difficulty of
the debtor) shall be accounted for as an extinguishment of the original financial liability d the
recognition of a new financial liability. (PAS 39 par.40)
The terms are substantially different if the discounted present value of the ash flows under the new
terms, including any fees paid net of any fees received and discounted using the original effective
interest rate, is at least 10 percent different from the discounted present value of e remaining cash
flows of the original financial liability.
liability. If an exchange of debt instruments or modification of terms
is accounted for as an extinguishment, any cost or fees incurred are recogni
recognized
zed as part of the gain
or loss on the extinguishment. If the exchange or modification is not accounted for as an
extinguishment, any cost or fees incurred adjust the carrying amount of the liability and are
amortized over the remaining term of the modified liability. (PAS 39 AC62)
The difference between the carrying amount of a financial liability for part of a financial liability
extinguished or transferred to another party and the consideration paid including any non cash
assets transferred or liabilities assumed, shall be recognized in profit or loss. (PAS 39 par. 41)
Question No. 4
Interest expense in 2010 (P262,694 x 10%)
P26,269
Question No. 5
Carrying amount, 12/31/10 (see no.3)
Less discount amortization for 2011:
Effective interest (P262,694 x 9%)
Nominal interest (P300,000 x 5%)
Carrying amount, 12/31/11
P262,694
P26,269
15,000
11,269
P273,963
PROBLEM NO. 24 – Income taxes
The following difference enter into the reconciliation of accounting profit and taxable profit of
Mulanay Company for the year ended December 31,2010, its first year of operations:
Life insurance expense
Excess tax depreciation
Warranty expense
Litigation accrual
P100,000
2,000,000
200,000
500,000
Unamortized
softwareon the books but
Unearned rentcomputer
income deferred
appropriately recognized in taxable profit
Interest income from long-term certificate deposit
3,000,000
400,000
200,000
Additional information:
a. On July 1,2010 Mulanay paid insurance premium of P200,000 o
on
n the life of an officer with
Mulanay Company as beneficiary.
b. Excess tax depreciation will reverse equally over a four-year
four- year period 2011-2014
c. The warranty liability is the estimated warranty cost that was recognized as expense in
2010 but deductible for tax purpose when actually paid.
d. It is estimated that the litigation liability eill be paid in 2014
e. In January 2010, Mulanay Company incurred P4,000,000 of computer software cost.
Considering the technical feasibility of the project, this cost was capitalized and amortized
over 4 years for accounting purposes. However, the total amount was expensed
exp ensed in 2010 for
tax purposes
f. Rent income will be recognized during the last year of the lease, 2014.
g. Interest income from the from long-term certificate of deposit is expected to be P200,000
year until
their
the end of 2014.
h. each
Accounting
profit
formaturity
2010 is at
P10,000,0000.
Tax rate is 35%
QUESTIONS:
Based on the above and the result of your audit, determine the following:
1.Deferred tax liability
a.
P1,050,000
c. P2,100,000
b. P1,890,000
d. P1,750,000
2.Deferred tax asset
a.
P385,000
c. P245,000
b. P1,085,000
d. P210,000
3.Current tax expense
a.
P2,100,000
c. P2,800,000
b. P1,750,000
d. P1,820,000
4.Tax expense
a.
P3,535,000
c. P3,465,000
b. P3,500,000
d. P4,830,000
Answers:1)D;
2)A;
3)A;
4)C
Suggested Solution:
Question No.1
Excess tax depreciation
Unamortized computer software cost
P2,000,000
3,000,000
Taxable temporary differences
P5,000,000
Deferred tax liability (P5,000,000 xx35%)
P1,750,000
Deferred tax liabilities are amounts of income taxes payable in future periods in respect of taxable
temporary differences
Taxable temporary differences are temporary differences that will result in taxable amounts in
determining taxable profit (tax loss) of future periods when the carrying amount of the asset or
liability is recovered or settled.
Temporary differences are differences between the carrying amount of an asset or liability in the
statement of financial position and its tax base.
Question No. 2
Warranty expense
Litigation Accrual
Unearned rent income
Deductible temporary differences
Deferred tax asset (P1,100,000 x 355)
P200,000
500,000
400,000
P1,100,000
P385,000
Deferred tax assets are the amounts of income taxes recoverable in future periods in respect of:
(a) Deductible temporary differences;
(b) The carryforward of unused tax losses; and
(c) The carryforward of unused tax credits
Deductible temporary differences are temporary differences that will result in amounts that
are deductible in determining taxable profit (tax loss) of future periods when the carrying
amount of the asset or liability is recovered or settled.
Question No. 3
Accounting profit
Nondeductible expense - life insurance expense
Nontaxable income - interest on LTCD
Accounting profit subject to income tax
Taxable temporary differences
Deductible temporary differences
Taxable profit
Current tax expensef(P6,000,000 x 35%)
P10,000,000
100,000
(200,000)
9,900,000
(5,000,000)
1,100,000
P6,000,000
P2,100,000
Current tax is the amount of income taxes payable (recoverable) in respect of the taxable profit
(tax loss) for a period.
Taxable profit (tax loss) is the profit (loss) for a period, determined in accordance with the rules
established by the taxation authorities, upon which income taxes are payable(recoverable).
Accounting profit is profit or loss for a period before deducting tax expense.
Question No. 4
Current tax expense
Increase in deferred tax liability
Increase in deferred tax asset
Total income tax expense
P2,100,000
1,750,000
(385,000)
P3,465,000
Alternative computation:
Accounting profit subject to income tax
Multiply by income tax rate
P9,900,000
_______35%
Total income tax expense
P3,465,000
Tax expense (tax income) is the aggregate amount included in the determination of profit or loss
for the period in respect of current tax and deferred tax. It comprises current tax expense (current
tax income) and deferred tax expense (deferred tax income).
PROBLEM NO. 25 – Income taxes
The accounting profit before tax for the year ended December 31,2010 for Doughty Corporation
amounted to P175,900 and included:
Interest income
Long-service leave expense
Doubtful dets expense
Depreciation - plant (15% p.a)
Rent expense
Entertainment expense (non-deductible)
P11,000
7,000
4,200
33,000
22,800
3,900
The draft statement of financial position at December 31,2010 contained the following assets and
liabilities:
Cash
2010
2009
P9,000
P7,500
Accounts
receivable
Allowance for doubtful debts
Inventory
Interest receivable
Prepaid rent
Plant
Accumulated depreciation-`plant
Deferred tax asset
Accounts payable
Provision for long-term service leave
Deferred tax
liability
83,000
(5,000)
67,100
1,000
2,800
220,000
(99,000)
?
71,200
64,000
76,800
(3,200)
58,300
0
2,400
220,000
(66,000)
30,600
73,600
61,000
?
720
Additional information

The tax depreciation rate for plant is 10%
1 0% p.a, straight line


The company
tax rate ishas
30%
The
P15,000 in tax losses carried forward from previous year.
QUESTIONS:
Based on the above and the result of your audit, compute for the following as of and for the year
ended December 31,2010:
1.Current tax liability
a.
P51,120
c. P58,260
b. P53,590
d. P53,760
2.Deferred tax liability
a. P1,140
b. P20,340
c. P19,200
d. P11,040
3.Deferred tax asset
a.
P24,000
c. P30,600
b. P12,540
d. P11,400
4.Deferred tax expense
a.
P180
b. P6,780
c. P36,300
d. P38,580
Answers:1)D;
2)A;
3)C;
4)A
Suggested Solution:
Question No. 1
Accounting profit
Add (deduct) adjustments:
Income and expenses - accounting
Interest income
Long-service leave expense
Doubtful dets expense
Depreciation - plant (15% p.a)
Rent expense
Entertainment expense (non-deductible)
P175,900
(11,000)
7,000
4,200
33,000
22,800
3,900
235,800
Income and expenses - taxation
Interest collected (P11,000-P1,000)
Long-service leave paid (P61,000+P7,000-P64,000)
Bad debts written off (P3,200+P4,200-P5,000)
Depreciation-plant (P2,800+P22,800-P2,400)
Rent paid (P2,800+P22,800-P2,400)
Tax losses from prior years
Taxable profit
Multiply
by rate
Current tax expense/liability
10,000
(4,000)
(2,400)
(22,000)
(23,200)
(15,000)
179,200
_____ 30%
P53,760
The following comparison of the carrying amount
a mount of assets and liabilities and their tax base at
December 31,2010 will be helpful in computing requirements 2 to 4:
Carrying amount
Tax base
Difference
Remarks**
P78,000
P83,000
P5,000
Deductible
1,000
2,800
121,000
154,000*
Accounts
receivable
Interest
receivable
Prepaid rent
Plant
Provision for
leave
*[P220,000 – (220,000 x .1 x.3)]
64,000
0
1,000
2,800
33,000
Taxable
Taxable
Deductible
64,000
Deductible
**If the carrying amount of asset is higher
h igher than tax base - Taxa
Taxable
ble
If the carrying amount of asset is lower than tax base – Deductible
If the carrying amount of liability is higher than tax base - Deductible
If the carrying amount of liability is lower than tax base - Taxable
Question No. 2
Taxable temporary differences
x tax rate
Deferred tax liability, 12/31/10
3,800
30%
P1,140
Question No. 3
Taxable temporary differences
x tax rate
Deferred tax liability, 12/31/10
P102,000
30%
P30,600
Question No. 4
Change in deferred tax liability (P1,140 - P720)
Change in deferred tax asswt (P30,600-P30,360)
Deferred tax expense (benefit)
P420
(240)
P180
PROBLEM NO. 26 – Substantive audit procedures for liabilities
Select the best answers for each of the following:
1. The auditor will most likely perform extensive test
t est for possible understatement of
a. Revenue
c. Liabilities
b. Assets
d. Equity
2. In auditing accounts payable, an auditor's procedures most likely will focus primarily on
management's assertion of
a. Existence
b. Completeness
c. Presentation and Disclosure
d. Valuation and allocation
3.Which of the following audit procedures is not appropriate for addressing the assertion of
valuation?
a. Confirm with creditors
b. Test for unrecorded liabilities.
c. Perform analytical procedures.
d. Verify accounts payable trial balance.
4.Which of the following is a substantive test that an auditor most likely would perform to verify
the existence and valuation of recorded accounts payable?
a. Vouching selected entries in the accounts payable subsidiary ledger to purchase orders and
receiving reports.
b. Confirming accounts payable balances with known suppliers who have zero balances.
c. Investigating the open purchase order file to ascertain that pre-numbered purchase orders are
used and accounted for.
d. Receiving the client's mail, unopened, for a reasonable period of time after the year-end to search
for unrecorded vendor's invoices.
5.Auditor confirmation of accounts payable balances at the end of the reporting period may be
unnecessary because
a. There is likely to be other reliable external evidence to support the balances.
b. The duplication of cut-off tests.
c. Accounts payable balances at the end
en d of the reporting period may not be paid before the audit is
completed.
d.Correspondence with the audit client's attorney will reveal all legal activity by vendors for
nonpayment.
6. To determine whether accounts payable are complete, an auditor performs a test to verify that
all merchandise received is recorded. The population
p opulation of documents for this test consists of all
a. Payments vouchers
c. Purchase requisitions
b. Receiving reports
d. Vendor’s invoices
7. An auditor traced a sample of purchase orders and the related receiving reports to the purchases
pu rchases
journal and the cash disbursement journal. The purpose of the substantive audit
aud it procedure most
likely was to
a. Verify that cash disbursements were for goods actually received.
b. Determine that purchases were properly recorded.
c. Test whether payments were for goods actually ordered.
d. Identify unusually large purchases that should be investigated earlier.
8. Which of the following procedures would an auditor most likely perform in searching for
unrecorded payables?
a. Compare cash payments occurring after the end of the reporting period with the accounts payable
trial balance
b. Reconcile receiving reports with related cash payments made just prior to year-end
c. Contrast the ratio of accounts payable
pa yable to purchases with the prior year’s ratio
d. Vouch a sample of creditor balances to supporting invoices, receiving reports, and purchase
orders
9. When an auditor selects a sample of items from the vouchers payable register for the last month
of the period under audit and traces these items to underlying documents, the auditor is gathering
evidence primarily in support of the assertion that
a. Recorded obligations were paid
b. Incurred obligations were recorded in the correct period
c. Recorded obligations were valid
d. Cash disbursements were recorded as incurred obligations
10. In conducting a search for unrecorded liabilities, the auditor should do all but the
th e following:
a. Examine prior year’s audit workpapers to ascertain that adjustments for unrecorded liabilities
have not been overlooked.
b. Examine invoices paid a few days prior to the end of the reporting period.
c. Examine paid invoices for a short period following the end of the reporting period and trace to
client’s year-end adjustments for unrecorded liabilities.
11. An audit procedure applicable
ap plicable to testing the year-end cutoff of liabilities is
a. Reviewing the general journal for unusual entries recorded immediately after year-end
b. Examining vendor invoices received subsequent to year-end for shipment date and terms of
shipment
c. Tracing recorded liabilities to supporting documents
d. Preparing an aging schedule for accounts payable
12. Two months before the year end, the bookkeeper erroneously recorded the receipt of a long
term bank loan by a debit to cash and credit to sales. Which of the following is the most effective
procedure for detecting this type of error?
a. Analyze the notes payable journal
b. Analyze bank confirmation information
c. Prepare a year-end bank reconciliation
d. Prepare a year end bank transfer schedule
13. An auditor usually examines receiving reports to support entries in the
a. Sales journal and sales return journal
b. Check register and sales journal
c. Voucher register and sales journal
d. Vouchers register and sales return journal
14. Which of the following is not used to test overstatements and understatements of accounts
payable?
a. Unmatched receiving reports
b. Canceled vouchers packages
c Cash receipts records
d. Cash disbursement records
15. During the course of an audit, an auditor observes that the recorded interest expense seems
excessive in relation to the balance in long term debt. This observation can lead the auditor to
suspect that
a. Long-term debt is overstated
b. Long-term debt is understated
c. Premium on bonds payable is understated
d. Discounts on bonds payable is overstated
16. An auditor’s program to examine long-term
long -term debt most likely would include steps that require
a. Correlating interest expense recorded for the period
pe riod with outstanding debt
b. Inspecting the accounts payable subsidiary ledger for unrecorded long term debt
c. Comparing the carrying amount of the debt to its year end market value
d. Verifying the existence of the holders of
o f the debt by direct confirmation
17. A CPA analyzes the accrued interest payable accounts for the year, recomputes the amounts
of payments and beginning and ending balances and reconciles to the interest expense account.
Which error or questionable practice below has the best chance of being detected by this specific
audit procedure?
a. Interest paid on an open account was charge to the purchase accounts
b. Interest revenue of P120 on a note receivable was credited against miscellaneous expense
c. A note payable had not been recorded. Interest of P300 on the note was properly paid and charge
to the interest expense accounts
d. There was a violation of a term in the client’s loan agreement prohibiting dividends
d ividends on common
stocks unless net income available for interest and dividends is at least three times interest,
requirements.
18. During the audit of a publicly held company, the auditor could obtain written confirmation
regarding long term bond transactions from the
a. Bond holders
c. Client’s Attorney
b. Internal Auditors
d. Trustee
19. During its fiscal year, a company
compan y issued, at a discounts, a substantial amount of first mortgage
bonds. When performing audit work, the independent auditors
a. Confirms the existence of the bondholders
b. Receiving the minutes for authorization
c. Traces the net cash received from the issuance to the bonds payable accounts
d. Inspects the records maintained by the bond trustee
20. An auditor’s purpose in reviewing the renewal of note payable shortly after the end of the
reporting period most likely is to obtain evidence concerning management’s assertions about
a. Existence
c. Presentation and Disclosure
b. Completeness
d. Valuation and Allocation
Answers:
1. c
6. b
11. b
16. a
2. b
7. b
12. b
17. c
3. c
8. a
13. d
18. d
4. a
9. c
14. c
19. b
5. a
10. b
15. b
20. c