FINANCIAL ACCOUNTING
THEORY & PRACTICE
PROVISIONS & CONTINGENCIES
QUIZZER
Provisions & Contingencies
PROVISIONS & CONTINGENCIES
Essay Questions
Estimated Liabilities / Provisions
1. What are "estimated liabilities"?
Estimated liabilities are obligations which exist at the end of reporting period although the
amount is not definite. In many cases, the date when the obligation is due is not also definite
and in some instances, the exact payee cannot be identified or determined. But in spite of
these circumstances, the existence of the estimated liabilities is valid and unquestioned.
Estimated liabilities are either current or noncurrent in nature. Examples include estimated
liability for premium, award points, warranties, gift certificates and bonus. Actually, an
estimated liability is considered as a "provision" which is both probable and measurable.
2.
What do you understand by the term "provision"?
A provision is an existing liability of uncertain timing or uncertain amount. The essence of a
provision is that there is uncertainty about the timing or amount of the future expenditure.
The liability definitely exists at the end of the reporting period but the amount is indefinite or
the date when the obligation is due is also indefinite, and in some cases, the payee cannot
be identified or determined. Actually, a provision may be the equivalent of an estimated
liability or a loss contingency that is accrued because it is both probable and measurable.
3.
Distinguish provision from other liabilities.
Paragraph 11 of PAS 37 states that provision can be distinguished from other liabilities,
such as trade payables and accruals, because there is uncertainty about the timing of amount
of the future expenditure required in settlement. In contrast, there is certainty about the
timing or amount of trade payables and accruals.
4.
What are the conditions for the recognition of a provision as liability?
PAS 37, paragraph 14, states that a provision shall be recognized as liability under the
following conditions:
1. The entity has a present obligation as a result of a past event.
2. It is probable that an outflow of economic benefits shall be required to settle the
obligation.
3. The amount of the obligation can be measured reliably.
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FINANCIAL ACCOUNTING
5.
What is a present obligation?
The present obligation may be legal or constructive. It is fairly clear what a legal obligation is.
A legal obligation is an obligation arising from a contract, legislation or other operation of law.
A constructive obligation is an obligation that is derived from an entity's actions where:
a. The entity has indicated to other parties that it will accept certain responsibilities by
reason of an established pattern of past practice, published policy, or a sufficiently
specific current statement.
b. And as a result the entity has created a valid expectation on the part of other parties that
it will discharge those responsibilities.
6.
What is an "obligating event"?
The past event that leads to a present obligation is called an obligating event.
An obligating event is an event that creates a legal or constructive obligation because the
entity has no realistic alternative but to settle the obligation created by the event.
This is the case where:
a. The settlement of the obligation can be enforced by law.
b. The event creates valid expectation on the part of other parties that the entity will
discharge the obligation, as in the case of constructive obligation.
7.
Explain briefly "probable outflow of economic benefits".
For a provision to qualify for recognition, there must be not only a present obligation but also
a probable outflow of resources embodying economic benefits to settle the obligation. An
outflow of resources is regarded as "probable" if the event is more likely than not to occur,
meaning, the probability that the event will occur is greater than the probability that it will not
occur. As a rule of thumb, "probable" means more than 50% likely.
8.
Explain the measurement of a provision.
The amount recognized as a provision should be the best estimate of the expenditure
required to settle the present obligation at the end of reporting period. The best estimate is
the amount that an entity would rationally pay to settle the obligation at the reporting date or
to transfer it to a third party at that time. Where a single obligation is being measured, the
individual most likely outcome may be the best estimate. However, even in such a case, the
entity shall consider other possible outcomes. Where there is a continuous range of possible
outcomes and each point in that range is as likely as any other, the midpoint of the range is
used.
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Provisions & Contingencies
9.
Explain the "expected value method" of measuring a provision.
This is the statistical method of estimation applied where the provision being measured
involves a large population of items. Under this method, the obligation is estimated by
"weighting" all possible outcomes by their associated possibilities.
10. Enumerate other considerations in the measurement of provision.
a. The risks and uncertainties that inevitably surround many events and circumstances
shall be taken into account in reaching the best estimate of a provision.
b. Where the effect of the time value of money is material, the amount of provision" shall
be the present value of the expenditures expected to be required to settle the obligation.
c. Future events that affect the amount required to settle an obligation shall be reflected in
the amount of a provision where there is a sufficient objective evidence that they will
occur. Examples of such future events include new legislation and changes in
technology.
d. Gains from expected disposal of assets shall not be taken into account in measuring a
provision.
e. Where some or all of the expenditure required to settle a provision is expected to be
reimbursed by another party, the reimbursement shall be recognized when it is virtually
certain that reimbursement will be received if the entity settles the obligation.
The reimbursement shall be treated as a separate asset and not "netted" against the
estimated liability for the provision.
The amount shall not exceed the amount of the provision. However, in the income
statement, the expense relating to the provision may be presented net of the
reimbursement.
f. Provisions shall be reviewed at each reporting date and adjusted to reflect the current
best estimate.
g. A provision shall be used only for expenditures for which the provision was originally
recognized.
h. Provision shall not be recognized for future operating losses.
i. If an entity has an onerous contract, the present obligation under the onerous contract
shall be recognized and measured as a provision.
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FINANCIAL ACCOUNTING
11. Explain an "onerous contract".
An onerous contract is a contract in which the unavoidable costs of meeting the obligation
under the contract exceed the economic benefits expected to be received under the contract.
PAS 37, paragraph 68, mandates that the unavoidable costs under a contract represent the
"least net cost of exiting from the contract". Such cost is the lower amount between the cost
of fulfilling the contract and the compensation or penalty arising from failure to fulfill the
contract.
12. Give examples of a provision.
1. Warranty. The best estimate of the warranty cost is recognized as a provision because
in this case there is clear legal obligation arising from an obligating event which is the
sale of the product with warranty.
2. Environmental contamination. If an entity has an environmental policy such that other
parties would expect the entity to clean up any contamination, or if the entity has broken
current environmental legislation, a provision for environmental, damage shall be made.
The obligating event is the contamination of the property which gives rise to constructive
or legal obligation. A provision is recognized for the best estimate of the cost of cleaning
up the contamination.
3. Decommissioning or abandonment cost. When an oil entity initially purchases an oil
field, it is put under a legal obligation to decommission the site at the end of its life. The
cost of abandonment or decommissioning shall be recognized as a provision and may
be capitalized as cost of the oil field.
4. Court case. After a wedding in the current year, ten people died possibly as a result of
food poisoning from products sold by the entity. Legal proceedings are started seeking
damages from the entity. When the entity prepares the financial statements for the
current year, its lawyers advise that owing to the development in the case, it is probable
that the entity would be found liable. A provision is recognized for the best estimate of
the damages because on the basis of available evidence, there is a present obligation.
5. Guarantee. In the current year, an entity gives a guarantee of certain borrowings of
another entity. During the year, the financial condition of the borrower deteriorates and
at year-end, the borrower files a petition for bankruptcy. A provision is recognized for
the best estimate of the guarantee obligation because there is a legal obligation arising
from the obligating event which is the guarantee. It is probable that an outflow of
resources embodying economic benefits would be required to settle the guarantee
obligation because there is a petition for bankruptcy on the part of the borrower.
Essay Questions
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Provisions & Contingencies
13. What is restructuring?
PAS 37, paragraph 10, defines restructuring as a "program that is planned and controlled by
management and materially changes either the scope of a business of an entity or the manner
in which that business is conducted".
Examples of events that may qualify as restructuring include:
a. Sale or termination of a hne of business.
b. Closure of business location in a region or relocation of business activities from one
location to another.
c. Change in management structure, such as elimination of a layer of management.
d. Fundamental reorganization of an entity that has a material and significant impact on the
operations.
14. Explain the recognition of a provision for restructuring.
A constructive obligation for restructuring arises when two conditions are present:
1. The entity has a detailed formal plan for the restructuring outlining at least the business
or part of the business being restructured, the principal location affected, the location,
function and approximate number of employees who will be compensated for terminating
their employment, when the plan will be implemented, and the expenditures that will be
undertaken.
2. The entity has raised valid expectation in the minds of those affected that the entity will
carry out the restructuring by starting to implement the plan and announcing its main
features to those affected by it.
15. What is the amount of the restructuring provision?
A restructuring provision shall include only direct expenditures arising from the restructuring,
meaning, those expenditures that are necessarily entailed by the restructuring and not
associated with the ongoing activities of the entity. For example, salaries and benefits of
employees to be incurred after operations cease and that are associated with the closure of
the operations shall be included in the amount of the restructuring provision.
PAS 37, paragraph 81, specifically excludes the following expenditures from the restructuring
provision:
a. Cost of retraining or relocating continuing staff.
b. Marketing or advertising program to promote the new entity image.
c. Investment in new system and distribution network.
Essay Questions
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FINANCIAL ACCOUNTING
Premiums & Coupons
16. Explain an estimated premium liability.
Premiums are articles of value such as toys, dishes, silverware, and other goods and in some
cases cash payments, given to customers as result of past sales or sales promotion activities.
In order to stimulate the sale of their products, entities offer premiums to customers in return
for product labels, box tops, wrappers and coupons. Accordingly, when the merchandise in
sold, an accounting liability for the future distribution of the premium arises and should be
given accounting recognition.
Product Warranty
17. Explain an estimated warranty liability.
Home appliances like television sets, stereo sets, ratio sets, refrigerators and the like are
often sold under guarantee or warranty to provide free repair service or replacement during
a specified period if the products are defective. Such entity policy may involve significant
costs on the part of the entity if the products sold prove to be defective in the future within the
specified period of time. Accordingly, at the point of sale, a constructive obligation arises and
a liability is incurred.
Contingent Liability
18. What is a contingent liability?
PAS 37, paragraph 10, defines a contingent liability in two ways:
1. A contingent liability is a possible obligation that arises from past event and whose
existence will be confirmed only by the occurrence or nonoccurrence of one or more
uncertain future events not wholly within the entity's control.
2. A contingent liability is a present obligation that arises from past event but is not
recognized because it is not probable that a transfer of economic benefits will be required
to settle the obligation or the amount of the obligation cannot be measured reliably.
19. Explain the three ranges of outcome of future uncertain events.
The uncertainty relating to future events can be expressed by a range of outcome.
The range of outcome may be described as follows:
a. Probable - The future event is likely to occur. As a rule of thumb, probable means more
than 50% likely.
b. Reasonably possible - The future event is less likely to occur.
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Provisions & Contingencies
c. Remote - The future event is least likely to occur or the chance of the future event
occurring is very slight.
20. Distinguish a contingent liability and a provision.
The second definition of contingent liability states that a contingent liability is a present
obligation. However, the present obligation is either probable or measurable but not both to
be considered a contingent liability. If the present obligation is both probable and
measurable, it is not a contingent liability but a provision to be recognized in the financial
statements.
21. What is the treatment of a contingent liability?
A contingent liability shall not be recognized in the financial statements but shall be disclosed
only.
Required disclosures in relation to contingent liability
a. Brief description of the nature of the contingent liability
b. An estimate of its financial effects
c. An indication of the uncertainties that exist
d. Possibility of any reimbursement
If the contingent liability is remote, no disclosure is necessary.
Contingent Asset
22. What is a contingent asset?
PAS 37, paragraph 10, defines a contingent asset as a "possible asset that arises from past
event and whose existence will be confirmed by the occurrence or nonoccurrence of one or
more uncertain future events not wholly within the entity's control". A contingent asset shall
not be recognized because this may result to recognition of income that may never be
realized. However, when the realization of income is virtually certain, the related asset is no
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FINANCIAL ACCOUNTING
longer contingent asset and its recognition is appropriate. A contingent asset is only
disclosed when it is probable. Required disclosures in relation to contingent asset
a. Brief description of the contingent asset.
b. An estimate of the financial effect.
If a contingent asset is only possible or remote, no disclosure is required.
MCQ - Theory
Provision
1. Which is the correct definition of a provision?
A. A liability of uncertain timing or amount
B. An obligation to transfer funds to an entity
C. A liability which cannot be easily measured
D. A possible obligation arising from past events
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2.
A legal obligation is an obligation that is derived from all of the following, except
A. A contract
B. Legislation
C. Other operation of law
D. An established pattern of past practice
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3.
A constructive obligation is an obligation
I. That is derived from an entity's action that the entity will accept certain responsibilities
because of past practice, published policy or current statement.
II. The entity has created a valid expectation in other parties that it will discharge those
responsibilities.
A. I only
C. Both I and II
B. II only
D. Neither I nor II
FA 2 © 2014
It is an event that creates a legal or constructive obligation because the entity has no other
realistic alternative but to settle the obligation.
A. Current event
C. Past event
B. Obligating event
D. Subsequent event
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For an event to be an obligating event, it is necessary that the entity has no realistic
alternative but to settle the obligation created by the event and this is the case only:
I. Where the settlement of the obligation can be enforced by law.
II. Where the event creates valid expectation in other parties that the entity will discharge
the obligation as in the case of a constructive obligation.
A. I only
C. Either I or II
B. II only
D. Neither I nor II
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4.
5.
MCQ – Theory
Page 8
Provisions & Contingencies
6.
It is a contract in which the unavoidable costs of meeting the obligation under the contract
exceed the economic benefits to be received under the contract.
A. Executed contract
C. Onerous contract
B. Executory contract
D. Sale contract
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7.
It is the abusive practice of manipulation and creative accounting by dumping all kinds of
provisions under the banner of provision for restructuring.
A. Big bath provision
C. Creative accounting
B. Cookie jar
D. General reserve
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8.
A provision shall be recognized when
A. There is a possible obligation arising from a past event, the outflow of resources is
probable, and an approximate, amount can be set aside toward the obligation.
B. There is a constructive obligation as a result of a past obligating event, the outflow of
resources is probable, and a reliable estimate can be made of the amount of the
obligation.
C. Management decides that it is essential that a provision be made for unforeseen
circumstances and keeping in mind this year the profits were enough but next year there
may be losses.
D. There is a legal obligation arising from a past obligating event, the probability of the
outflow of resources is more than remote but less than probable, and a reliable estimate
can be made of the amount of the obligation.
FA 2 © 2014
9.
A provision shall be recognized when
I. An entity has a present obligation as a result of a past event.
II. It is probable that an outflow of resources embodying economic benefits will be required
to settle the obligation.
III. The amount of the obligation can be measured reliably.
A. I and II only
C. II and III only
B. I and III only
D. I, II and III
FA 2 © 2014
10. Which of the following terms is associated with recognizing a provision?
A. Likely
C. Probable
B. Possible
D. Remote
MCQ – Theory
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11. Which of the following statements is true in relation to recognition of a provision?
I. No provision is recognized for costs that need to be incurred to operate in the future.
II. A provision for the decommissioning of an oil installation or a nuclear plant station shall
be recognized to the extent that an entity is obliged to rectify damage already caused.
A. I only
C. Both I and II
B. II only
D. Neither I nor II
FA 2 © 2014
12. An outflow of resources embodying economic benefits is regarded as "probable" when
A. The probability that the event will occur is 90% likely.
B. The probability that the event will occur is greater than the probability that the event will
not occur.
C. The probability that the event will not occur is greater than the probability that the event
will occur.
D. The probability that the event will occur is the same as the probability that the event will
not occur.
FA 2 © 2014
13. Which of the following statements is incorrect concerning recognition of a provision?
A. Provisions shall be recognized for future operating losses.
B. A provision shall be used only for expenditures for which the provision was originally
recognized.
C. Provisions shall be reviewed at the end of each reporting period and adjusted to reflect
the current best estimate.
D. If an entity has an onerous contract, the present obligation under the contract shall be
recognized and measured as a provision.
FA 2 © 2014
14. A provision should be recognized for which of the following?
A. Future operating losses
B. Obligations under insurance contracts
C. Obligations for plant decommissioning costs
D. Reductions in fair value of financial instruments
FA 2 © 2014
15. Provisions shall be recognized for all of the following, except
A. Rectification costs relating to defective products already sold.
B. Restructuring costs after a binding sale agreement has been signed.
C. Future refurbishment costs due to introduction of a new computer system.
D. Cleaning-up costs of contaminated land when an oil entity has a published policy that it
will undertake to clean up all contamination that it causes.
FA 2 © 2014
MCQ – Theory
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Provisions & Contingencies
16. What amount is recognized as provision?
A. Best estimate of the expenditure
C. Midpoint of the range
B. Maximum of the range
D. Minimum of the range
FA 2 © 2014
17. The unavoidable costs under an onerous contract represent the "least net cost of exiting from
the contract", which is equal to
A. Cost of fulfilling the contract
B. Penalty arising from failure to fulfill the contract
FA 2 © 2014
C. Higher of the cost of fulfilling the contract or the penalty arising from failure to fulfill the
contract
D. Lower of the cost of fulfilling the contract or the penalty arising from failure to fulfill the
contract
18. When the provision involves a large population of items, the estimate of the amount
A. Midpoint of the possible outcomes.
B. Is determined as the individual most likely outcome.
FA 2 © 2014
C. Reflects the weighting of all possible outcomes by their associated probabilities.
D. May be the individual most likely outcome adjusted for the effect of other possible
outcomes.
19. When the provision arises from a single obligation, the estimate of the amount
A. Midpoint of the possible outcomes.
B. Is determined as the individual most likely outcome.
C. Reflects the weighting of all possible outcomes by their associated probabilities.
D. Is the individual most likely outcome adjusted for the effect of other possible outcomes.
20. Where there is a continuous range of possible outcomes, and each point in that range is as
likely as any other, the range to be used is the
A. Midpoint
B. Minimum
C. Maximum
D. Summation of the minimum and maximum
FA 2 © 2014
21. Which of the following statements is true concerning the measurement of a provision?
I. The amount recognized as a provision should be the best estimate of the expenditure
required to settle the present obligation at the end of reporting period.
II. The best estimate of the expenditure required to settle the present obligation is the
amount that an entity would rationally pay to settle the obligation at the end of reporting
period or to transfer it to a third party at that time.
A. I only
C. Both I and II
B. II only
D. Neither I nor II
FA 2 © 2014
MCQ – Theory
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FINANCIAL ACCOUNTING
22. Which of the following statements is true in relation to the measurement of a provision?
I. The risks and uncertainties that inevitably surround many events and circumstances
shall be taken into account in reaching the best estimate of a provision.
II. Where the effect of the time value of money is material, the amount of a provision shall
be the present value of the expenditure expected to settle the obligation.
A. I only
C. Both I and II
B. II only
D. Neither I nor II
FA 2 © 2014
23. Which of the following statements is true in relation to measurement of a provision?
I. Future events that may affect the amount required to settle the obligation shall be
reflected in the amount of the provision where there is sufficient objective evidence that
the future events will occur.
II. Gains from expected disposal of assets shall be taken into account in measuring a
provision.
A. I only
C. Both I and II
B. II only
D. Neither I nor II
FA 2 © 2014
24. Which of the following statements is incorrect where some or all of the expenditure required
to settle a provision is expected to be reimbursed by another party?
A. The amount of the reimbursement shall not exceed the amount of the provision.
B. The reimbursement shall be "netted" against the estimated liability for the provision.
C. In the income statement, the expense relating to the provision may be presented net of
the reimbursement.
D. The reimbursement shall be recognized only when it is virtually certain that the
reimbursement will be received if the entity settles the obligation.
FA 2 © 2014
25. Provisions shall be discounted if the effect is material. Which of the following is incorrect
regarding the discount rate?
A. Is a post-tax discount rate
B. Reflects risk specific to the liability.
C. Reflects current market assessment of the time value of money.
FA 2 © 2014
D. Does not reflect risk for which future cash flow estimates have already been adjusted.
26. This is defined as "a structured program that is planned and controlled by the management
that materially changes either the scope of a business of an entity or the manner in which
that business is conducted".
A. Corporate revamp
C. Recapitalization
B. Liquidation
D. Restructuring
FA 2 © 2014
MCQ – Theory
Page 12
Provisions & Contingencies
27. Examples of events that qualify as restructuring include all of the following, except
A. Sale or termination of business
B. Change in management structure such as elimination of a layer of management
C. Closure of business location in a region or relocation of business from one location to
another
D. Fundamental reorganization of an entity that has an immaterial and insignificant impact
on its operations.
FA 2 © 2014
28. Which is a cost of restructuring?
A. Marketing or advertising cost
B. Cost of retraining or relocating continuing staff
C. Investment in new system and distribution network
D. Cost of relocating business activities from one location to another
FA 2 © 2014
29. A provision for restructuring is required when
I. The entity has a detailed plan for the restructuring.
II. The entity has raised valid expectation in the minds of those affected that the entity will
carry out the restructuring by announcing its main features to those affected by it.
A. I only
C. Both I and II
B. II only
D. Neither I nor II
FA 2 © 2014
30. How should incurred costs associated with relocating employees in a restructuring be
accounted for?
A. Recognized when costs are paid.
B. Measured at fair value and recognized over two years.
C. Measured at fair value and treated as prior period error.
D. Measured at fair value and recognized when the liability is incurred.
FA 2 © 2014
31. An entity is closing one of its operating divisions, and the conditions for making restructuring
provision have been met. The closure will happen in the first quarter of the next financial year.
At the current year-end, the entity has announced the formal plan publicly and is calculating
the restructuring provision. Which of the following costs should be included in the
restructuring provision?
A. Retraining staff continuing to be employed
B. Relocation costs relating to staff moving to other divisions
C. Future operating losses of the division being closed up to the date of closure
D. Contractually required costs of retraining staff being made redundant from the division
being closed
FA 2 © 2014
MCQ – Theory
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FINANCIAL ACCOUNTING
32. The board of directors of an entity decided in the latter part of the current year to wind up
international operations in the Far East and move them to Australia. The decision was based
on a detailed formal plan of restructuring as required by PAS 37. This decision was conveyed
to all workers and management personnel at the headquarters in Europe. The.cost of this
restructuring plan can be measured reliably. How should the entity treat this restructuring in
the financial statements for the current year-end?
FA 2 © 2014
A. Mention the decision to restructure and the cost involved in the chairman's statement in
the annual report since it is a decision of the board of directors.
B. Because the restructuring has not commenced before year-end, based on prudence,
wait until next year and do nothing in this year's financial statements.
C. Recognize a provision for restructuring since the board of directors has approved it and
it has been announced in the headquarters of the entity in Europe.
D. Disclose only the restructuring decision and the cost of restructuring because the entity
has not announced the restructuring to those affected by the decision and thus has not
raised an expectation that the entity would actually carry out the restructuring.
33. An entity operates chemical plants. Its published policies include a commitment to making
good any damage caused to the environment by its operations. It has always honored this
commitment. Which of the following scenarios relating to the entity would give rise to an
environmental provision?
A. The government has outlined plans for a new law requiring all environmental damage to
be rectified.
B. A chemical spill from one of the entity's plants has caused harm to the surrounding area
and wildlife.
C. Recent research suggests there is a possibility that the entity's actions may damage
surrounding wildlife.
D. On past experience it is likely that a chemical spill which would result in having to pay
fines and penalties will occur in the next year.
FA 2 © 2014
34. What condition is necessary to recognize an environmental liability?
A. Obligating event has occurred.
B. The entity has an existing legal obligation.
C. The entity can reliably estimate the amount of the liability.
D. The entity has an existing legal obligation and the amount of the liability can be reliably
estimated.
FA 2 © 2014
MCQ – Theory
Page 14
Provisions & Contingencies
Product Warranty
35. The accrual approach in accounting for product warranty cost
A. Is required for income tax purposes.
B. Is frequently justified on the basis of expediency when warranty cost is immaterial.
C. Finds the expense account being charged when the seller performs in compliance with
the warranty.
D. Represents accepted practice and should be used whenever the warranty is an integral
and inseparable part of the sale.
FA 2 © 2014
36. Which of the following best describes the accrual approach of accounting for warranty cost?
A. Expensed when paid.
B. Expensed when incurred.
C. Expensed based on estimate in year of sale.
D. Expensed when warranty claims are certain.
FA 2 © 2014
37. Which of the following best describes the expense as incurred approach of accounting for
warranty cost?
A. Expensed when incurred.
B. Expensed when liability is accrued.
C. Expensed when warranty claims are certain.
D. Expensed based on estimate in year of sale.
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38. An entity has a continuing policy of guaranteeing new products against defects for three
years. What is the classification of the estimated warranty liability?
A. Current
C. Noncurrent
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B. No need for disclosure
D. Partly current and partly noncurrent
39. An entity sells appliances that include a three-year warranty. Service calls under the warranty
are performed by an independent mechanic under a contract with the entity. Based on
experience, warranty costs are expected to be incurred for each machine sold. When should
the entity recognize these warranty costs?
A. When the machines are sold
B. Evenly over the life of the warranty
C. When the service calls are performed
D. When payments are made to the mechanic
AICPA 1194
MCQ – Theory
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FINANCIAL ACCOUNTING
40. An entity sells furnaces that include a three-year warranty. The entity can contract with a
third party to provide these warranty services. The entity elects the fair value option for
reporting financial liabilities. At what amount should the entity report the warranty liability?
A. The cost of expected warranty services
B. The present value of expected warranty costs
C. The fair value of the contract to settle the warranty services
D. The fair value of the contract less the cost to provide the services
Wiley 2011
41. Which of the following is a characteristic of the accrual of warranty but not the sale of
warranty?
A. Warranty expense
C. Warranty revenue
B. Warranty liability
D. Unearned warranty revenue FA 2 © 2014
Contingent liability
42. A contingent liability is
A. An estimated liability.
B. A potential large liability.
C. A potential small liability.
D. An event which is not recognized because it is not probable that an outflow will be
required or the amount cannot be reliably estimated.
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43. Contingent liabilities will or will not become actual liabilities depending on
A. The degree of uncertainty.
B. The outcome of a future event.
C. Whether they are probable and estimable.
D. The present condition suggesting a liability.
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44. Which of the following statements is incorrect concerning a contingent liability?
A. A contingent liability is disclosed only.
B. A contingent liability is both probable and measurable.
C. If a contingent liability is remote, no disclosure is required.
FA 2 © 2014
D. An entity shall not recognize a contingent liability in the financial statements.
45. A contingent liability is a
I. Possible obligation that arises from past event and whose existence will be confirmed
only by the occurrence or nonoccurrence of one or more future uncertain events not
wholly within the control of the entity.
II. Present obligation that arises from past event and it is not probable that an outflow of
resources embodying economic benefits will be required to settle the obligation OR the
MCQ – Theory
Page 16
Provisions & Contingencies
amount of the obligation cannot be measured reliably.
A. I only
C. Both I and II
B. II only
D. Neither I nor II
FA 2 © 2014
46. Which of the following statements in relation to a contingent liability is true?
I. An obligation as a result of the entity creating a valid expectation that it will discharge its
responsibilities is a contingent liability.
II. A present obligation that arises from past event but cannot be reliably measured is a
contingent liability.
A. I only
C. Both I and II
B. II only
D. Neither I nor II
FA 2 © 2014
47. Pending litigation would generally be considered
A. Contingent liability
C. Estimated liability
B. Current liability
D. Nonmonetary liability
FA 2 © 2014
48. A contingent liability
A. Is the result of a loss contingency.
B. Is not recognized in the financial statements.
C. Is accrued even though not reasonably estimated.
D. Definitely exists as a liability but the amount and due date are indeterminable. FA 2 ©
2014
49. Which of the following is not considered when evaluating whether or not to record a liability
for pending litigation?
A. The type of litigation involved.
B. The probability of an unfavorable outcome.
C. Time period in which the underlying cause of action occurred.
D. The ability to make a reliable estimate of the amount of the loss.
FA 2 © 2014
50. Reporting is required for
A. All loss contingencies.
B. Loss contingencies that are possible and can be reliably measured.
C. Loss contingencies that are probable and can be reliably measured.
D. Gain contingencies that are probable and can be reliably measured.
MCQ – Theory
FA 2 © 2014
Page 17
FINANCIAL ACCOUNTING
51. A contingent liability shall be recognized when
A. Any lawsuit is actually filed against an entity.
B. It is certain that funds are available to pay the amount of the claim.
C. It is probable that a liability has been incurred even though the amount of the loss cannot
be reasonably estimated.
D. The amount of the loss can be reasonably estimated and it is probable prior to issuance
of financial statements that a liability has been incurred.
FA 2 © 2014
52. Provisions are accrued because the likelihood of an unfavorable outcome is
A. At least 75%
C. Possible
B. Greater than 50%
D. Virtually certain
FA 2 © 2014
53. A present obligation that is probable and for which the amount can be reliably estimated shall
A. Be accrued by debiting an expense account and crediting a liability account.
B. Not be accrued but shall be disclosed in the notes to the financial statements.
C. Be accrued by debiting an appropriated retained earnings account and crediting a liability
account.
D. Be accrued by debiting an expense account and crediting an appropriated retained
earnings account.
FA 2 © 2014
54. An entity has a self-insurance plan. Each year, the entity appropriated retained earnings for
contingencies in an amount equal to insurance premiums saved less recognized losses from
lawsuits and other claims. As a result of an accident in the current year, the entity is a
defendant in a lawsuit in which it will probably have to pay measurable amount of damages.
What are the effects of this lawsuit's probable outcome on the entity's financial statements
for the current year?
A. No effect on either expenses or liabilities
B. An increase in both expenses and liabilities
C. An increase in expenses and no effect on liabilities
D. No effect on expenses and an increase in liabilities
FA 2 © 2014
55. An entity did not record an accrual for a present obligation but disclose the nature of the
obligation and the range of the loss. How likely is the loss?
A. Certain
C. Reasonably possible
B. Probable
D. Remote
FA 2 © 2014
MCQ – Theory
Page 18
Provisions & Contingencies
56. How should a contingent liability be reported in the financial statements when it is reasonably
possible that the entity will have to pay the liability at a future date?
A. As a disclosure only
B. As a deferred liability
C. As an accrued liability
FA 2 © 2014
D. As an account payable with an additional disclosure explaining the nature of the
transaction
57. A competitor has sued an entity for unauthorized use of its patented technology. The amount
that the entity may be required to pay to the competitor if the competitor succeeds in the
lawsuit is determinable with reliability, and according to the legal counsel it is less than
probable but more than remote that an outflow of the resources would be needed to meet the
obligation. The entity that was sued shall at year-end
A. Recognize a provision for this possible obligation.
B. Make a disclosure of the possible obligation in footnotes to the financial statements.
C. Set aside, as an appropriation, a contingency reserve, an amount based on the best
estimate of the possible liability.
D. Make no provision or disclosure and wait until the lawsuit is finally decided and then
expense the amount paid on settlement, if any.
FA 2 © 2014
58. Which of the following should be disclosed in the financial statements as a contingent liability?
A. The entity has not yet paid certain claims under sales warranties.
B. The entity has received a letter from a supplier complaining about an old unpaid invoice.
C. The entity is involved in a legal case which it may possibly lose, although this is not
probable.
D. The entity has accepted liability prior to the year-end for unfair dismissal of an employee
and is to pay damages.
FA 2 © 2014
59. The likelihood that the future event will or will not occur can be expressed by a range of
outcome. Which range means that the future event occurring is very slight?
A. Certain
C. Reasonably possible
B. Probable
D. Remote
FA 2 © 2014
60. Disclosure usually is not required for
A. Contingent losses that are remote and can be reasonably estimated.
B. Contingent gains that are probable and can be reasonably estimated.
C. Contingent losses that are probable and cannot be reasonably estimated. FA 2 © 2014
D. Contingent losses that are reasonably possible and cannot be reasonably estimated.
MCQ – Theory
Page 19
FINANCIAL ACCOUNTING
61. An entity has been served a legal notice at year-end by the Department of Environment and
Natural Resources to fit smoke detectors in its factory on or before middle of the next year.
The cost of fitting smoke detector can be measured reliably. How should the entity treat this
in its financial statements at year-end?
A. Ignore the event.
B. Recognize a provision for the current year equal to the estimated amount.
C. Recognize a provision for the current year equal to one-half only of the estimated
amount.
D. No provision is recognized at year-end because there is no present obligation for the
future expenditure since the entity can avoid the future expenditure by changing the
method of operations, but disclosure is required.
FA 2 © 2014
62. Which of the following statements is incorrect concerning contingent liability?
A. A contingent liability is disclosed only.
B. A contingent liability is both probable and measurable.
C. If the contingent liability is remote, no disclosure is required.
D. A contingent liability is not recognized in the financial statements.
FA © 2014
Contingent assets
63. It is a possible asset that arises from past event and whose existence will be confirmed only
by the occurrence or nonoccurrence of one or more uncertain future events not wholly within
the control of the entity.
A. Asset in suspense
C. Contingent gain
B. Contingent asset
D. Possible asset
FA 2 © 2014
64. Contingent assets are usually recognized when
A. Realized
B. The amount can be reasonably estimated
C. Occurrence is probable and the amount can be reasonably estimated
FA 2 © 2014
D. Occurrence is reasonably possible and the amount can be reasonably estimated
65. Which of the following is the proper way to report a contingent asset, receipt of which is
virtually certain?
A. As a disclosure only
C. As unearned revenue
FA 2 © 2014
B. As an asset
D. No disclosure and no accrual
MCQ – Theory
Page 20
Provisions & Contingencies
66. A factory owned by an entity was destroyed by fire. The entity lodged an insurance claim for
the value of the factory building and plant, and an amount equal to one year's net profit.
During the year, there were a number of meetings with the representatives of the insurance
company. Finally, before year-end, it was decided that the entity would receive compensation
for 90% of its claim. The entity received a letter that the settlement check for that amount had
been mailed but it was not received before year-end. How should the entity treat this in the
financial statements?
A. Disclose the contingent asset in the footnotes.
B. Record 90% of the claim as a receivable as it is virtually certain that the contingent asset
will be received.
C. Wait until next year when the settlement check is actually received and not recognize
this receivable at all since at year-end it is a contingent asset.
D. Record 100% of the claim as a receivable at year-end as it is virtually cetain that the
contingent asset will be received, arid adjust the 10% next year when the settlement
check is actually received.
FA 2 © 2014
67. When the occurrence of a contingent asset is probable and the amount can be reasonably
estimated, the contingent asset should be
A. Classified as an appropriation of retained earnings.
B. Recognized in the statement of financial position and disclosed.
C. Disclosed but not recognized in the statement of financial position.
D. Neither recognized in the statement of financial position nor disclosed.
FA 2 © 2014
68. Which of the following is the proper accounting treatment of a probable contingent asset?
A. A disclosure only
B. Deferred earnings
C. An accrued account
D. An account receivable with an additional disclosure explaining the nature of the
transaction
69. At year-end, an entity was suing a competitor for patent infringement. The award from the
probable favorable outcome could be reasonably estimated. The entity's financial statements
should report the expected award as
A. Disclosure only
C. Receivable and reduction of patent
B. Receivable and deferred revenue
D. Receivable and revenue FA 2 © 2014
MCQ – Theory
Page 21
FINANCIAL ACCOUNTING
70. Which of the following statements is incorrect concerning a contingent asset?
A. A contingent asset is disclosed where an inflow of economic benefits is probable.
B. A contingent asset is disclosed where an inflow of economic benefits is possible or
remote.
C. A contingent asset is not recognized because this may result to recognition of income
that may never be realized.
D. When the realization of income is virtually certain, the related asset is no longer a
contingent asset and its recognition is appropriate.
FA 2 © 2014
71. Which of the following statements is incorrect concerning a contingent asset?
A. The related gain arising from the contingent asset is recognized usually when it is
realized.
B. A contingent asset is only disclosed when the occurrence of the future event is possible
or remote.
C. When the realization of income is virtually certain, the related asset is no longer
contingent asset and its recognition is appropriate.
D. A contingent asset is not recognized in the financial statements because this may result
to recognition of income that may never be realized.
FA © 2014
72. An entity operates a plant in a foreign country. It is probable that the plant will be expropriated.
However, the foreign government has indicated that the entity will receive a definite amount
of compensation for the plant. The amount of compensation is less than the fair value but
exceeds the carrying amount of the plant. The contingent asset should be reported
A. In the statement of financial position
B. In the notes to the financial statements
C. As a fixed asset valuation allowance account
D. As a valuation allowance as part of shareholders' equity
FA 2 © 2014
73. Gain contingencies that are remote and can be reliably measured
A. Must be reported.
B. May be disclosed.
C. Must be disclosed.
D. Should not be reported or disclosed.
MCQ – Theory
FA 2 © 2014
Page 22
Provisions & Contingencies
Disclosures
74. Which of the following is required to be disclosed regarding risk and uncertainties that exist?
A. Factor causing an estimate to be sensitive.
B. A description of operations both within and outside of the home country.
C. The potential impact of estimate when it is remotely possible that the estimate will change
in the future.
D. The potential impact of estimate when it is reasonably possible that the estimate will
change in the future.
FA 2 © 2014
MCQ – Theory
Page 23
FINANCIAL ACCOUNTING
MCQ - Problems
Provisions - Composition
1. Iriga Company issued the 2013 financial statements on March 1,2014. The following data are
provided by the entity for the year ended December 31,2013:
Amount owing to another entity for services rendered during December 2013 300,000
Estimated long service leave owing to employees in respect of past services 1,200,000
Estimated cost of relocating an employee from head office to a
branch in another city (employee will physically relocate in January 2014) 100,000
Estimated cost of overhauling machine every 5 years
(the machine is 5 years old on December 31, 2013)
150,000
What amount should be recognized as provision on December 31, 2013?
A. 1,200,000
C. 1,600,000
B. 1,300,000
D. 1,750,000
Premiums & Coupons
2. Summa Company manufactures a special product. To promote the sale of the product, a
premium is offered to customers who send in three wrappers and remittance of P25. The
distribution cost per premium is P5. Data for the premium are.
2014
2015
Sales
4,000,000
5,000,000
Premium purchase at P80 each
400,000
416,000
Number of premiums distributed
4,000
5,500
Number of premiums to be distributed in next period
200
500
What amount should be reported as premium expense for 2015?
A. 330,000
C. 360,000
B. 348,000
D. 464,000
FA 2 © 2014
3.
Las Palmas Company included one coupon in each package of cereal sold. A towel is offered
as a premium to customers who send in 10 coupons. Data for the premium offer are:
2014
2015
Packages of cereal sold
500,000
800,000
Number of towels purchased at P40 per towel
30,000
60,000
Number of towels distributed as premium
20,000
50,000
Number of towels to be distributed as premium next period
5,000
3,000
What amount should be reported as premium expense for 2015?
A. 1,920,000
C. 2,120,000
B. 2,000,000
D. 2,400,000
FA 2 © 2014
MCQ – Problems
Page 24
Provisions & Contingencies
4.
In an effort to increase sales, Mills Company inaugurated a sales promotional campaign on
June 30, 2014. The entity placed a coupon redeemable for a premium in each package of
cereal sold. Each premium cost P20 and five coupons must be presented by a customer to
receive a premium. The entity estimated that only 60% of the coupons issued will be
redeemed. For the six months ended December 31, 2014, the following information is
available:
Packages of cereal sold
160,000
Premiums purchased
12,000
Coupons redeemed
40,000
What is the estimated liability for premium claims outstanding on December 31, 2014?
A. 169,000
C. 288,000
B. 224,000
D. 384,000
FA 2 © 2014
5.
On January 1, 2014, Roca Company began marketing a new soft drink. To help promote the
soft drink, the management is offering a special gift, a T-shirt, to each customer who returns
10 bottle caps. The entity estimated that out of the 250,000 bottles sold in 2014, only 80%
will be redeemed. On December 31, 2014, the following information was collected:
Units
Amount
T-shirts purchased
18,000
1,800,000
T-shirts distributed
15,000
What is the estimated premium liability on December 31, 2014?
A. 200,000
C. 500,000
B. 300,000
D. 700,000
FA 2 © 2014
Clam Company offers its customers a pottery cereal bowl if they send in three boxtops from
its products and P10. The entity estimated that 60% of the boxtops will be redeemed. In 2014,
the entity sold 675,000 boxes and customers redeemed 330,000 boxtops receiving 110,000
bowls. The cost of each bowl is P25. What is the liability for outstanding premiums on
December 31, 2014?
A. 250,000
C. 625,000
B. 375,000
D. 875,000
FA 2 © 2014
At the beginning of current year, Daisy Company began marketing a new beer called
"Serbesa". To help promote the product, the management is offering a special Serbesa beer
mug to each customer for every 20 specially marked bottle caps of Serbesa. The entity
estimated that out of the 300,000 bottles of Serbesa sold during the year, only 50% of the
marked bottle caps would be redeemed. During the year, the entity purchased 8,000 beer
mugs at a total cost of P360.000 or P45 each and had already distributed 4,500 mugs to
customers. What is the estimated premium liability at year-end?
A. 135,000
C. 337,500
B. 202,500
D. 360,000
FA 2 © 2014
6.
7.
MCQ – Problems
Page 25
FINANCIAL ACCOUNTING
8.
Topsy Company started a new promotional program. For every 10 box tops returned,
customers receive a basketball. The entity estimated that only 60% of the box tops reaching
the market will be redeemed. Additional information is as follows:
Units
Amount
Sales of product
100,000
30,000,000
Basketball purchased
5,500
4,125,000
Basketball distributed
4,000
What is the amount of year-end estimated liability associated with this promotion?
A. 1,500,000
C. 4,125,000
B. 3,000,000
D. 4,500,000
FA 2 © 2014
9.
Bare Company included one coupon in each box of laundry soap it sold. A towel is offered
as a premium to customers who send in 10 coupons and a remittance of P20. Data for the
premium offer are:
2014
2015
Boxes of soap sold
500,000
800,000
Number of towels purchased (P100 per towel)
20,000
25,000
Coupons redeemed
140,000
200,000
The entity's experience indicated that only 30% of the coupons will be redeemed.
What amount should be reported as estimated premium liability on December 31, 2015?
A. 80,000
C. 400,000
B. 320,000
D. 500,000
FA 2 © 2014
10. In an effort to increase sales, Blue Company inaugurated a sales promotion campaign on
June 30, 2014, whereby the entity placed a coupon in each package of razor blades sold, the
coupons being redeemable for a premium. Each premium costs P50 and five coupons must
be presented by a customer to receive a premium. The entity estimated that only 60 percent
of the coupons issued will be redeemed. For the six months ended December 31, 2014, the
following information is available:
Packages of razor blades sold
400,000
Premiums purchased
30,000
Coupons redeemed
100,000
What is the estimated liability for premium claims outstanding on December 31, 2014?
A. 1,000,000
C. 1,800,000
B. 1,400,000
D. 2,400,000
FA 2 © 2014
MCQ – Problems
Page 26
Provisions & Contingencies
11. During 2014, Day Company sold 500,000 boxes of cake mix under a new sales promotional
program. Each box contained one coupon, which entitled the customer to a baking pan upon
remittance of P40. The entity paid P50 per pan and P5 for handling and shipping.
The entity estimated that 80% of the coupons will be redeemed, even though only 300,000
coupons had been processed during 2014.
What amount should be reported as liability for unredeemed coupons on December 31,
2014?
A. 1,000,000
C. 3,000,000
B. 1,500,000
D. 5,000,000
FA 2 © 2014
12. In packages of the products, Curran Company included coupons that may be presented at
retail stores to obtain discounts. Retailers are reimbursed for the face amount of coupons
redeemed plus 10% of that amount for handling costs. The entity granted requests for coupon
redemption by retailers up to three months after the consumer expiration date. The entity
estimated that 70% of all coupons issued will ultimately be redeemed.
Consumer expiration date
December 31, 2014
Total face amount of coupons issued
600,000
Total payments to retailers as of December 31,2014
220,000
What amount should be reported as liability for unredeemed coupons on December 31,
2014?
A. 0
C. 242,000
B. 200,000
D. 308,000
FA 2 © 2014
13. Cereal Company frequently distributes coupons to promote new products. On October 1,
2014, the entity mailed 100,000 coupons for P45 off each box of cereal purchased and
expected 12,000 of these coupons to be redeemed before the December 31, 2014 expiration
date. It takes -30 days from the redemption date for the entity to receive the coupons from
the retailers. The entity reimburses the retailers an additional P5 for each coupon redeemed.
On December 31, 2014, the entity had paid retailers P250,000 related to these coupons and
had 5,000 coupons on hand that had not been processed for payment.
What amount should be reported as liability for coupons on December 31, 2014?
A. 225,000
C. 290,000
B. 250,000
D. 350,000
FA 2 © 2014
14. Energy Company offered a cash rebate of P10 on each P40 package of batteries sold during
2013. Historically, 10% of customers mail in the rebate form. During 2013, 6,000,000
packages of batteries are sold, and 210,000 P10 rebates are mailed to customers. What
amount of rebate expense and liability for rebates should be reported respectively, on
December 31,2013?
A. 2,100,000 and 3,900,000
C. 6,000,000 and 3,900,000
B. 3,900,000 and 3,900,000
D. 6,000,000 and 6,000,000
P1 @ 2013
MCQ – Problems
Page 27
FINANCIAL ACCOUNTING
Product Warranty
15. Mile Company sells washing machines that carry a three-year warranty against
manufacturer's defects. Based on entity experience, warranty costs are estimated at P300
per machine. During the current year, the entity sold 2,400 washing machines and paid
warranty costs of P170,000. What amount should be reported as warranty expense for the
current year?
A. 170,000
C. 550,000
B. 240,000
D. 720,000
FA 2 © 2014
16. East Company manufactures stereo systems that carry a two-year warranty against defects.
Based on past experience, warranty costs are estimated at 5% of sales for the warranty
period. During the current year, stereo system sales amounted to P5,000,000 and warranty
costs of P100,000 were incurred. What amount should be reported as warranty expense for
the current year?
A. 100,000
C. 150,000
B. 125,000
D. 250,000
FA 2 © 2014
17. Erwin Company offers a three-year warranty on the products sold. The entity previously
estimated warranty costs to be 2% of sales. Due to a technology advance in production at
the beginning of 2014, the entity now believed 1% of sales to be a better estimate of warranty
costs. Warranty costs of P80,000 and P96..000 were reported in 2012 and 2013, respectively.
Sales for 2014 amounted to P5,000,000. What amount should be reported as warranty
expense for 2014?
A. 50,000
C. 100,000
B. 88,000
D. 138,000
FA 2 © 2014
18. Chato Company sells electrical goods covered by a one-year warranty for any defects. Of the
sales of P70,000,000 for the year, the entity estimated that 3% will have major defect, 5%
will have minor defect and 92% will have no defect. The cost of repairs would be P5,000,000
if all the products sold had major defect and P3,000,000 if all had minor defect. What amount
should be recognized as a warranty provision?
A. 190,000
C. 5,600,000
B. 300,000
D. 8,000,000
FA 2 © 2014
19. Toyo Company owns a car dealership that it uses for servicing cars under warranty. In
preparing its financial statements, the entity needs to ascertain the provision for warranty that
it would be required to provide at the end of the year.
The entity's experience with warranty claims is as follows: 60% of all cars sold in a year have
zero defect, 25% of all cars sold in a year have normal defect, and 15% of all cars sold in a
MCQ – Problems
Page 28
Provisions & Contingencies
year have significant defect.
The cost of rectifying a "normal defect" in a car is P10,000. The cost of rectifying a "significant
defect" in a car is P30,000. The entity sold 500 cars during the year.
What is the "expected value" of the warranty provision for the current year?
A. 1,400,000
C. 3,500,000
B. 1,750,000
D. 4,000,000
FA 2 © 2014
20. Bizarre Company gives warranties at the time of sale to purchasers of its product. The entity
undertakes to make good, by repair or replacement, manufacturing defects that become
apparent within one year from the date of sale. Sales of P10,000,000 were made evenly
throughout 2013. The expenditures for warranty repairs and replacements for the products
sold in 2013 are expected to be made 50% in 2013 and 50% in 2014. The 2014 outflows of
economic benefits related to the warranty will take place on June 30,2014.
The entity estimated that 95% of products sold require no warranty repairs, 3% of products
sold require minor repairs costing 10% of the sale price, and 2% of products sold require
major repairs or replacement costing 90% of sale price.
The appropriate discount factor for cash flows expected to occur on June 30,2014 is 0.95.
An appropriate risk adjustment factor to reflect the uncertainties in the cash flow estimates is
an increment of 6% to the probability-weighted expected cash flows. What is the warranty
provision on December 31,2013?
A. 105,735
C. 210,000
B. 111,300
D. 222,600
P1 @ 2013
21. Humanizer Company gives warranties at the time of sale to purchasers of its product. Under
the terms of the sale, the entity undertakes to make good, by repair or replacement,
manufacturing defects that become apparent within one year from the date of sale.
On December 31,2013, the entity appropriately recognized P50,00C warranty provision. The
entity incurred and charged P140,000 against the warranty provision in 2014. Out of the PI
40,000, an amount of P80,000 related to warranties for sales made in 2014. The increase
during 2014 in the discounted amount recognized as a provision on December 31,2013
arising from the passage of time is P2,000.
On December 31, 2014, the entity estimated that it would incur expenditures in 2015 to meet
its warranty obligations on December 31, 2014 as follows:




5% probabihty of P400,000
20% probability of P200,000
50% probability of P 80,000
25% probability of P 20,000
MCQ – Problems
Page 29
FINANCIAL ACCOUNTING
Assume for simplicity that the 2015 cash flows for warranty repairs and replacements take
place on June 30,2015.
An appropriate discount rate is 10% per year. The PV of 1 at 10% for one year is 0.91 and
the PV of 1 at 10% for 6 months is 0.95. An appropriate risk adjustment factor to reflect the
uncertainties in the cash flow estimates is an increment of 8% to the probability-weighted
expected cash flows.
What is the warranty expense to be recognized in 2014?
A. 107,730
C. 187,730
B. 185,000
D. 195,730
P1 @ 2013
22. Villa Company estimated annual warranty expense at 8% of net sales. The following data
relate to the current year:
Net sales
?
Warranty liability, January 1
Before adjustment
100,000 debit
After adjustment
540,000 credit
What is the amount of net sales for the current year?
A. 1,250,000
C. 6,750,000
B. 5,500,000
D. 8,000,000
FA 2 © 2014
23. On April 1, 2014, Ash Company began offering a new product for sale under a one-year
warranty. Of the 5,000 units in inventory at April 1, 2014, 3,000 had been sold by June 30,
2014. Based on its experience with similar products, the entity estimated that the average
warranty cost per unit sold would be P80. Actual warranty costs incurred from April 1 through
June 30, 2014, were P70.000. On June 30, 2014, what amount should be reported as
estimated warranty liability?
A. 90,000
C. 170,000
B. 160,000
D. 330,000
FA 2 © 2014
24. Bold Company estimated annual warranty expense at 2% of annual net sales. The net sales
for the current year amounted to P4,000,000. On January 1, 2014, the warranty liability was
P60,000 and the warranty payments during the year totaled P50,000. What is the warranty
liability on December 31, 2014?
A. 10,000
C. 80,000
B. 70,000
D. 90,000
FA 2 © 2014
MCQ – Problems
Page 30
Provisions & Contingencies
25. Bass Company manufactures high-end home electronic systems. The entity provided a oneyear warranty for all products sold. The entity estimated that the warranty cost is P200 per
unit sold and reported a liability for estimated warranty cost of P650,000 on January 1, 2014.
During the current year, the entity sold 5,000 units for a total of P2,450,000 and paid warranty
claims of P750,000 on current and prior year sales. What amount of warranty liability should
be reported on December 31, 2014?
A. 250,000
C. 750,000
B. 350,000
D. 900,000
FA 2 © 2014
26. During 2014, Rex Company introduced a new product carrying a two-year warranty against
defects. The estimated warranty costs related to peso sales are 2% within 12 months
following sale and 4% in the second 12 months following sale. Sales are P6,000,000 for 2014
and Pi0,000,000 for 2015. Actual warranty expenditures are P90,000 for 2014 and P300,000
for 2015. On December 31, 2015, what is the estimated warranty liability?
A. 0
C. 450,000
B. 100,000
D. 570,000
FA 2 © 2014
27. In 2014, Dubious Company began selling new line of products that carry a two-year warranty
against defects. Based upon past experience with other products, the estimated warranty
costs related to peso sales are as follows:
First year of warranty
2%
Second year of warranty
5%
Sales and actual warranty expenditures are presented below:
2014
2015
Sales
5,000,000
7,000,000
Actual warranty costs
100,000
300,000
What is the estimated warranty liability on December 31, 2015?
A. 390,000
C. 490,000
B. 440,000
D. 840,000
FA 2 © 2014
Dismantling cost
28. Dubai Company purchased an oil rig for P5,000,000 on January 1, 2014. The life of the rig is
10 years and the expected cost to dismantle the rig at the end of 10 years is P1,000,000. The
appropriate discount rate for the entity is 10%. The present value of the dismantling cost at
10% is P385,000. What expense should be recorded in the current year as a result of these
events?
A. Depreciation expense of P600,000.
B. Depreciation expense of P500,000 and interest expense of P38,500.
C. Depreciation expense of P538,500 and interest expense of P38,500.
D Depreciation expense of P500,000 and interest expense of P100,000.
FA 2 © 2014
MCQ – Problems
Page 31
FINANCIAL ACCOUNTING
Restructuring provision
29. Helen Company decided on November 1,2013 to restructure the entity's operations as
follows:
 Factory A would be closed down and put on the market for sale.
 Employees working in Factory A would be retrenched on November 30,2013, and would
be paid their accumulated entitlements plus six months' wages.
 Some employees working in Factory A would be transferred to Factory B, which would
continue operating.
On December 31,2013, the following transactions and events had occurred:
 The retrenched employees have left and their accumulated entitlements have been paid.
However, an amount of P1,000,000, representing a portion of the six months' wages for
the retrenched employees, has still not been paid.
 Costs of P300,000 are expected to be incurred in transferring the remaining employees
to their new work in Factory B. The transfer is planned for January 15,2014.
 One employee, Juan Cruz, remains in order to complete administrative tasks relating to
the closure of Factory A and the transfer of employees to Factory B. Juan Cruz is
expected to stay until January 31,2014. His salary for January will be P50,000 and his
retrenchment package will be P150,000, all of which will be paid on the day he leaves.
Juan Cruz would spend 60% of his time administering the closure of Factory A, 30% on
administering the transfer of employees to Factory B, and the remaining 10% on general
administration.
What total amount should be recognized as restructuring provision on December 31,2013?
A. 1,180,000
C. 1,480,000
B. 1,200,000
D. 1,500,000
Provision for relocation costs
30. In May 2014, Cherry Company relocated an employee from the Manila head office to a branch
in Zamboanga City. As of the end of the reporting period on June 30, 2014, the costs were
estimated to be P350,000 analyzed as follows:
Cost for shipping goods
30,000
Airfare
10,000
Temporary accommodation cost for May and June
80,000
Temporary accommodation cost for July and August
90,000
Reimbursement for lease break cost paid in July
(lease was terminated in May)
20,000
Reimbursement for cost of living increases for the
period May 1, 2014 to May 1, 2015
120,000
MCQ – Problems
Page 32
Provisions & Contingencies
What amount should be reported as provision for relocation costs on June 30, 2014?
A. 140,000
C. 240,000
B. 160,000
D. 250,000
FA 2 © 2014
Provision for loan guarantee
31. During 2014, Manfred Company guaranteed a supplier's P500,000 loan from a bank. On
October 1, 2014, the entity was notified that the supplier had defaulted on the loan and filed
for bankruptcy protection. Counsel believed the entity will probably have to pay P250,000
under its guarantee. As a result of the supplier's bankruptcy, the entity entered into a contract
in December 2014 to retool its machines so that the entity could accept parts from other
suppliers. Retooling costs are estimated to be P300,000.
What amount should be reported as accrued liability on December 31, 2014?
A. 250,000
C. 550,000
B. 450,000
D. 750,000
FA 2 © 2014
Provision for product recall
32. Zoe Company is preparing the annual financial statements on December 31, 2014. Because
of a recently proven health" hazard in one of the products, the Philippine government has
clearly indicated its intention of requiring the entity to recall all cans of this product sold in the
last three months. The management of the entity estimated that this recall would cost
P580,000. What accounting recognition should be accorded this situation?
A. No recognition
B. Note disclosure only
C. Expense of P580,000 and liability of P580,000
D. Expense of P580,000 and retained earnings restriction of P580,000
FA 2 © 2014
Provision for lawsuit
33. On February 5, 2015, an employee filed a P2,000,000 lawsuit against Steel Company for
damages suffered when a plant of the entity exploded on December 29, 2014. The entity's
legal counsel believed the entity will probably lose the lawsuit and estimated the loss to be
P500,000. The employee has offered to settle the lawsuit out of court for P900,000 but the
entity will not agree to the settlement.
In the December 31, 2014 statement of financial position, what amount should be reported
as accrued liability from lawsuit?
A. 500,000
C. 1,000,000
B. 900,000
D. 2,000,000
FA 2 © 2014
MCQ – Problems
Page 33
FINANCIAL ACCOUNTING
34. Concord Company sells motorcycle helmets. In 2014, the entity sold 4,000,000 helmets
before discovering a significant defect in their construction. By December 31, 2014, two
lawsuits had been filed against the entity. The first lawsuit, which the entity has little chance
of winning, is expected to be settled out of court for P1,500,000 in January 2015.
The attorneys think the entity has a 50-50 chance of winning the second lawsuit which is for
P1,000,000.
What is the accrued liability on December 31, 2014 as a result of the lawsuits?
A. 0
C. 1,500,000
B. 1,000,000
D. 2,500,000
FA 2 © 2014
35. Winter Company is being sued for illness caused to local residents as a result of negligence
on the entity's part in permitting the local residents to be exposed to highly toxic chemicals
from its plant. The entity's lawyer stated that it is probable that the entity will lose the suit and
be found liable for a judgment costing the entity anywhere from P1,200,000 to P6,000,000.
However, the lawyer estimated that the most probable cost is P3,600,000. What amount
should be accrued and disclosed?
A. No loss contingency but disclose a contingency of Pl.200,00.0 to P6,000,000.
B. A loss contingency of P3,600,000 but not disclose any additional contingency.
C. A loss contingency of P3,600,000 and disclose an additional contingency of up to
P2,400,000.
D. A loss contingency of Pi,200,000 and disclose an additional contingency of up to
P4,800,000.
FA 2 © 2014
36. On December 31, 2014, Mith Company was a defendant in a pending lawsuit. In the opinion
of the entity's attorney, it is probable that Mith Company will have to pay P500,000 and it is
reasonably possible that Mith Company will have to pay P600,000 as a result of this lawsuit.
What should be reported in the 2014 financial statements?
A. No information about this lawsuit.
B. An accrued liability of P500,000 only.
C. An accrued liability of P600,000 only.
FA 2 © 2014
D. An accrued liability of P500,000 and disclosure of a contingent liability of P100,000
37. A Malaysian-based shipping entity lost an entire shipload of cargo valued at P5,000,000 on
a voyage to Australia. It is however covered by an insurance policy. According to the report
of the surveyor, the amount is collectible, subject to the deductible clause in the insurance
policy. Before year-end, the shipping entity received a letter from the insurance entity that a
check was in the mail for 90% of the claim.
MCQ – Problems
Page 34
Provisions & Contingencies
The international freight forwarding entity that entrusted the shipping entity with the delivery
of the cargo overseas has filed a lawsuit for P5,000,000, claiming the value of the cargo that
was lost on high seas, and also consequential damages of P2,000,000 resulting from the
delay.
According to the legal counsel for the shipping entity, it is probable that the shipping entity
would have to pay the P5,000,000 but it is a remote possibility that it would have to pay the
additional P2,000,000 claimed by the international freight forwarding entity, since this loss
was specifically excluded in the freight forwarding contract.
What provision should be recognized by the shipping entity at year-end?
A. 0
C. 5,000,000
B. 500,000
D. 7,000,000
P1 © 2013
38. During 2014, Odyssey Company is the defendant in a patent infringement lawsuit. The
entity's lawyers believe there is a 30% chance that the court will dismiss the case and the
entity will incur no outflow of economic benefits. However, if the court rules in favor of the
claimant, the lawyers believe that there is a 20% chance that the entity will be required to pay
damages of P200,000 and an 80% chance that the entity will be required to pay damages of
P100,000. Other outcomes are unlikely. The court is expected to rule in late December 2015.
There is no indication that the claimant will settle out of court. A 7% risk adjustment factor to
the probability-weighted expected cash flows is considered appropriate to reflect the
uncertainties in the cash flow estimates. An appropriate discount rate is 5% per year. The
present value of 1 at 5% for one period is 0.95. What is the measurement of the provision for
lawsuit on December 31, 2014?
A. 84,000
C. 89,880
B. 85,386
D. 100,000
FA 2 © 2014
39. During 2014, Libya Company is the defendant in a breach of patent lawsuit. The lawyers
believe there is an 80% chance that the court will not dismiss the case and the entity will incur
outflow of benefits. If the court rules in favor of the claimant, the lawyers believe that there is
a 60% chance that the entity will be required to pay damages of P2,000,000 and a 40%
chance that the entity will be required to pay damages of PI,000,000. Other amounts of
damages are unlikely. The court is expected to rule within three months. There is no indication
that the claimant will settle out of court. An 8% risk adjustment factor to the cash flows is
considered appropriate to reflect the uncertainties in the cash flow estimates. The court is
expected to rule in late December 2015. The appropriate discount rate is 12%. The PV of 1
at 12% for one period is .89. What is the measurement of the provision on December 31,
2014?
A. 1,139,200
C. 1,280,000
B. 1,230,336
D. 1,382,400
FA 2 © 2014
MCQ – Problems
Page 35
FINANCIAL ACCOUNTING
40. During 2013, Libya Company is the defendant in a breach of patent lawsuit. The lawyers
believe there is an 80% chance that the court will not dismiss the case and the entity will incur
outflow of benefits. If the court rules in favor of the claimant, the lawyers believe that there is
a 60% chance that the entity will be required to pay damages of P2,000,000 and a 40%
chance that the entity will be required to pay damages of P1,000,000. Other amounts of
damages are unlikely. The court is expected to rule in late December 2014. There is no
indication that the claimant will settle out of court.
A 7% risk adjustment factor to the cash flows is considered appropriate to reflect the
uncertainties in the cash flow estimates. An appropriate discount rate is 10% per year. The
present value of 1 at 10% for one period is 0.91. What is the measurement of the provision
on December 31, 2013?
A. 1,246,336
C. 1,369,600
B. 1,280,000
D. 1,500,000
P1 © 2013
41. On November 5, 2014, a Dunn Company truck was in an accident with an auto driven by Bell.
The entity received notice on January 12, 2015 of a lawsuit for P700,000 damages for
personal injuries suffered by Bell. The entity's counsel believed it is probable that Bell will be
awarded an estimated amount in the range between P200,000 and P500,000. The possible
outcomes are equally likely. The accounting year ends on December 31 and the 2014
financial statements were issued on March 2, 2015.
What amount of provision should be accrued on December 31, 2014?
A. 0
C. 350,000
B. 200,000
D. 500,000
FA 2 © 2014
42. On November 5,2013, a Dunn Company truck was in an accident with an auto driven by Bell.
Dunn received notice on January 15, 2014 of a lawsuit for P700,000 damages for personal
injuries suffered by Bell. The entity's counsel believed it is probable that Bell will be awarded
an estimated amount in the range between P200,000 and P450,000, and no amount is a
better estimate of potential liability than any other amount because each point in the range is
as likely as any other. The 2013 financial statements were issued on March 1, 2014. What
amount of loss should be accrued on December 31,2013?
A. 0
C. 325,000
B. 200,000
D. 450,000
P1 © 2013
43. On November 25, 2014, an explosion occurred at a Rex Company plant causing extensive
property damage to area buildings. By March 10, 2015, claims had been asserted against
Rex Company. The management and counsel concluded that it is probable Rex Company
will be responsible for damages, and that P3,500,000 would be a reasonable estimate of its
liability. The entity's P10,000,000 comprehensive public liability policy has a P500,000
MCQ – Problems
Page 36
Provisions & Contingencies
deductible clause.
What should be reported in the December 31, 2014 financial statements which were issued
on March 25, 2015?
A. An accrued liability of P500,000.
B. An accrued liability of P3,500,000.
C. A footnote disclosure indicating the probable loss of P3,500,000.
D. A footnote disclosure indicating the probable loss of P500,000.
FA 2 © 2014
44. Nia Company is involved in litigation regarding a faulty product sold in a prior year. The entity
has consulted with an attorney and determined that it is possible that the entity may lose the
case. The attorney estimated that there is a 40% chance of losing. If this is the case, the
attorney estimated that the amount of any payment would be P5,000,000. What is the
required journal entry as a result of this litigation?
A. No journal entry is required.
FA 2 © 2014
B. Debit litigation expense for P2,000,000 and credit litigation liability for P2,000,000.
C. Debit litigation expense for P3,000,000 and credit litigation liability for P3,000,000.
D. Debit litigation expense for P5,000,000 and credit litigation liability for P5,000,000.
45. Tone Company is the defendant in a lawsuit filed by Witt in 2013 disputing the validity of
copyright held by Tone. On December 31, 2013, Tone determined that Witt would probably
be successful for an estimated amount of P400,000. Appropriately, a P400,000 loss was
accrued by a charge to income for the year ended December 31, 2013.
On December 31, 2014, Tone and Witt agreed to a settlement providing for cash payment of
P250,000 by Tone to Witt, and transfer of Tone's copyright to Witt. The carrying amount of
the copyright on Tone's accounting records was P60,000 on December 31, 2014. What would
be the effect of the settlement on Tone's income before tax in 2014?
A. 150,000 increase
C. 90,000 decrease
B. 60,000 decrease
D. 90,000 increase
FA 2 © 2014
46. Prime Company has long owned a manufacturing site that has now been discovered to be
contaminated with toxic waste. The entity has acknowledged its responsibility for the
contamination. An initial clean up feasibility study has shown that it will cost at least P500,000
to clean up the toxic waste. During the current year, the entity has been sued for patent
infringement and lost the case. A preliminary judgment of P300,000 was issued and is under
appeal. The entity's attorneys agree that it is probable that the entity will lose this appeal.
What amount of provision should be accrued as liability?
A. 0
C. 500,000
B. 300,000
D. 800,000
P1 © 2013
MCQ – Problems
Page 37
FINANCIAL ACCOUNTING
47. Eastern Company has several contingent liabilities on December 31,2013. The auditor
obtained the following brief description of each liability.
 In May 2013, Eastern Company became involved in litigation. In December 2013, the
court assessed a judgment for P1,600,000 against Eastern. The entity is appealing the
amount of the judgment. The entity's attorneys believed it is probable that they can
reduce the assessment on appeal by 50%.
 In July 2013, Pasig City brought action against Eastern Company for polluting the Pasig
River with its waste products. It is probable that Pasig City will be successful but the
amount of damages Eastern might have to pay should not exceed P1,500,000.
What total amount should be accrued as provision on December 31,2013?
A. 1,500,000
C. 2,300,000
B. 1,600,000
D. 3,100,000
P1 © 2013
Gain contingencies
48. During the current year, Haze Company won a litigation award for PI,500,000 which was
tripled to P4,500,000 to include punitive damages. The defendant, who is financially stable,
has appealed only the P3,000,000 punitive damages. The entity was awarded P5,000,000 in
an unrelated suit it filed, which is being appealed by the defendant. Counsel is unable to
estimate the outcome of these appeals.
In the income statement for the current year, what amount of pretax gain should be reported?
A. 1,500,000
C. 5,000,000
B. 4,500,000
D. 9,500,000
FA 2 © 2014
49. On January 1, 2014, Brenda Company owned a machine with cost of P2,000,000. The
accumulated depreciation was PI,200,000, estimated residual value was P120,000 and fair
value was P3,200,000. On January 3, 2014, this machine was irreparably damaged by Lann
Company and became worthless. In October 2014, a court awarded damages of P3,200,000
against Lann in favor of Brenda. On December 31, 2014, the final outcome of this case was
awaiting appeal and was therefore uncertain. However, in the opinion of Brenda's attorney,
Lann's appeal will be denied. On December 31, 2014, what amount of gain should be
accrued?
A. 0
C. 260,000
B. 200,000
D. 320,000
FA 2 © 2014
50. In May 2014, Caso Company filed suit against Wayne Company seeking PI,900,000
damages for patent infringement. A court verdict in November 2014 awarded Caso Company
PI,500,000 in damages, but Wayne Company's appeal is not expected to be decided before
2015.
MCQ – Problems
Page 38
Provisions & Contingencies
The legal counsel believed it is probable that Caso Company will be successful against
Wayne Company for an estimated amount in the range between P800,000 and Pi, 100,000,
with PI,000,000 considered the most likely amount.
What amount should Caso Company record as income from the lawsuit for the year ended
December 31, 2014?
A. 0
C. 1,100,000
B. 1,000,000
D. 1,500,000
FA 2 © 2014
51. During 2014, Smith Company filed suit against West Company seeking damages for patent
infringement. On December 31, 2014, the legal counsel believed that it was probable that
Smith Company would be successful against West Company for an estimated amount of
PI,500,000. In March 2015, Smith Company was awarded PI,000,000 and received full
payment thereof.
In Smith Company's 2014 financial statements issued February 2015, how should this award
be reported?
A. As a receivable and revenue of P1,000,000.
B. As a disclosure of a contingent asset of P1,500,000.
C. As a disclosure of a contingent asset of P1,000,000.
D. As a receivable and deferred revenue of P1,000,000.
FA 2 © 2014
Events after the reporting period
52. Caress Company carried a provision of P2,000,000 in the draft financial statements on
December 31, 2014 in relation to an unresolved court case. On January 31, 2015, when the
financial statements on December 31, 2014 had not yet been authorized for issue, the case
was settled and the court decided the damages payable by Caress Company to be
P2,800,000. What amount should be adjusted on December 31, 2014 in relation to this
event?
A. 0
C. 2,000,000
B. 800,000
D. 2,800,000
FA 2 © 2014
53. During 2014, Thor Company was sued by a competitor for P5,000,000 for infringement of a
trademark. Based on the advice of the entity's legal counsel, the entity accrued the sum of
P3,000,000 as a provision in the financial statements for the year ended December 31, 2014.
Subsequent to the end of the reporting period, on February 15, 2015, the Supreme Court
decided in favor of the party alleging infringement of the trademark and ordered the defendant
to pay the aggrieved party a sum of P3,500,000. The financial statements were prepared by
the entity's management on January 31, 2015, and approved by the board of directors on
February 20, 2015. What amount of provision should have been accrued on December 31,
2014?
A. 0
C. 3,500,000
B. 3,000,000
D. 5,000,000
FA 2 © 2014
MCQ – Problems
Page 39
FINANCIAL ACCOUNTING
54. Ginger Company is completing the preparation of the draft financial statements for the year
ended December 31, 2014. The financial statements are authorized for issue on March
31,2015.
On March 15, 2015, a dividend of P1,750,000 was declared and a contractual profit share
payment of P350,000 was made, both based on the profit for the year ended December 31,
2014. On February 1, 2015, a customer went into liquidation having owed the entity P340,000
for the past 5 months. No allowance had been made against this debt in the draft financial
statements. On March 20, 2015, a manufacturing plant was destroyed by fire resulting in a
financial loss of P2,600,000. What total amount should be recognized in profit or loss for the
year ended December 31, 2014 to reflect adjusting events after the end of reporting period?
A. 690,000
C. 2,600,000
B. 1,750,000
D. 3,290,000
FA 2 © 2014
55. Elysee Company reported in the draft financial statements for the year ended December 31,
2014 profit before tax of P9,000,000. The board of directors authorized the financial
statements for issue on March 20, 2015.
A fire occurred at one of Elysee's sites on January 15, 2015 with resulting damage costing
P7,000,000, only P4,000,000 of which is covered by insurance. The repairs will take place
and be paid for in April 2015. The P4,000,000 claim from the insurance entity will however
be received on February 14, 2015. What amount should be reported as profit before tax for
2014?
A. 2,000,000
C. 9,000,000
B. 6,000,000
D. 13,000,000
FA 2 © 2014
56. During 2014 Beal Company became involved in a tax dispute with the BIR. On December
31, 2014, the entity's tax advisor believed that an unfavorable outcome was probable and the
best estimate of additional tax was P500,000, but could be as much as P650,000. After the
2014 financial statements were issued, the entity received and accepted a BIR settlement
offer of P550,000. What amount of accrued liability should be reported on December 31,
2014?
A. 0
C. 550,000
B. 500,000
D. 650,000
FA 2 © 2014
Noncurrent liabilities
57. Jam Company had P5,000,000 note payable that is due on March 1, 2015. The entity
borrowed P3,500,000 on February 1, 2015 which has a five-year term and used the proceeds
to pay down the note and used other cash to pay the balance. The 2014 financial statements
were issued on March 31, 2015. What amount of the note payable should be classified as
noncurrent on December 31, 2014?
MCQ – Problems
Page 40
Provisions & Contingencies
A. 0
B. 1,500,000
C. 3,500,000
D. 5,000,000
FA 2 © 2014
58. Dana Company had P2,000,000 note payable due on June 30, 2015. Under the existing loan
facility, the entity had the discretion to refinance or roll over the note payable for at least
twelve months after the end of reporting period. On December 31, 2014, what amount of the
note payable should be reported as noncurrent liability?
A. 0
C. 2,400,000
B. 2,000,000
D. 3,000,000
FA 2 © 2014
Total liabilities
59. Ducky Company reported the following information on December 31, 2014:
Accounts payable
1,000,000
Advances to employees
45,000
Unearned rent revenue
300.000
Estimated liability under warranties
250,000
Cash surrender value of officers' life insurance
75,000
Bonds payable
5,000,000
Discount on bonds payable
500,000
Trademark
50,000
What amount should be reported in the statement of financial position as total liabilities?
A. 1,550,000
C. 6,095,000
B. 6,050,000
D. 7,050,000
FA 2 © 2014
Straight Problems
Premium & coupon
60. Miracle Company manufacturers a product that is packaged and sold. A plate is offered to
customers sending in three wrappers accompanied by a remittance of P10. Data with respect
to the premium offer are summarized below.
2014
2015
Sales
3,600,000
4,200,000
Purchase of premium (P50 per plate)
390,000
580,000
Number of plates distributed as premiums
5,000
9,000
Estimated number of plates to be
distributed in subsequent period
2,000
3,000
Distribution cost P20 per plate
MCQ – Straight Problems
Page 41
FINANCIAL ACCOUNTING
Required:
Prepare journal entries that would be made in 2014 and 2015 to record sales, premium
purchases and redemptions, and year-end adjustments.
61. Pop Company sells banana juice. In order to promote the drink among teenagers and others
who might otherwise be indifferent to the product, the entity inaugurated in the current year
a premium plan called "Drink-N-Win." For every 10 bottle caps and P5 turned in, customers
receive an attractive ball-pen and become eligible for a grand prize of P5,000 in cash which
is awarded for every 100 tops turned in. The entity estimated that only 25% of bottle caps
reaching the hands of customers will be presented for redemption.
During the current year, the entity sold 400,000 bottles of banana juice at P9 each, purchased
10,000 ball point pens for a total cost of P900,000, and incurred nondeferrable costs of
P30,000 applicable to the premium plan. A total of 8,000 pens have been redeemed and
thirty grand prizes have been awarded. At the end of the year, the entity recognized an
estimated liability equal to the estimated cost of prizes outstanding.
Required:
Prepare journal entries to record the transactions relating to the premium plan for the current
year.
62. Cascade Company manufactures a special laundry soap. A towel is offered as a premium to
customers who send in two proof-of-purchase seals from the soap boxes and a remittance
of P20. Distribution cost is P5 per towel. Data for the premium offer are.
2014
2015
Soap sales
2,500,000
3,125,000
Towel purchases (P100 per towel)
175,000
200,000
Number of towels distributed as premium
1,000
1,800
Number of towels expected to be
distributed in subsequent period
600
800
Required:
1. Prepare journal entries for 2014 and 2015.
2. Statement classification of the account balances pertaining to the premium plan.
MCQ – Straight Problems
Page 42
Provisions & Contingencies
Customer loyalty program
63. Erika Company operates a customer loyalty program. The entity grants loyalty points for
goods purchased. The loyalty points can be used by the customers in exchange for goods of
the entity. The points have no expiry date.
During 2014, the entity issued 50,000 award credits and expects that 80% of these award
credits shall be redeemed. The fair value of the of the award credits is reliably measured at
P2,000,000. In 2014, the entity sold goods to customers for a total consideration of
P9,000,000 including the fair value of the award credits.
The award credits redeemed and the total award credits expected to be redeemed each year
are as follows:
Redeemed
Expected to be redeemed
2014
15,000
80%
2015
7,950
85%
2016
2,550
85%
2017
15,000
90%
Required
Prepare journal entries from 2014 to 2017.
64. Susan Company participates in a customer loyalty program operated by an airline in which
customers earn air travel points when they purchase goods from the entity. The air travel
points can be redeemed for free air travel. The entity pays the airline P50 per air travel point
and considers that the fair value of the air travel point is P60. During the current year, the
entity sold goods for P5,000,000 and granted 5,000 points.
Required
Prepare journal entries for the current year assuming the entity is the principal in the
transaction and the entity is an agent of the airline.
Product warranty
65. Socorro Company sells color television sets with a two-year repair warranty. The sale price
for each set is P15,000. The average repair cost per set is P800. Research has shown that
20% of all sets sold are repaired in the first year and 40% in the second year. The number of
sets sold were as follows: 300 in 2014, 500 in 2015. Total payments for repairs associated
with the warranties were P40,000 in 2014, P150,000in2015.
MCQ – Straight Problems
Page 43
FINANCIAL ACCOUNTING
Required:
1. Prepare journal entries in connection with the warranty using the "expense as incurred"
approach.
2. Prepare journal entries in connection with the warranty using the "accrual" approach.
3. Determine the estimated warranty liability on December 31,2015.
4. Analyze the estimated warranty liability account to ascertain whether actual warranty
costs approximate the estimate. The sales and warranty repairs are made evenly during
the year.
5. Prepare journal entry to correct the estimated warranty liability on December 31, 2015.
66. In 2014, Dare Company began selling a new calculator that carried a two-year warranty
against defects.
Dare projected the estimated warranty cost (as a percent of sales) as follows:
First year of warranty
4%
Second year of warranty
10%
Sales and actual warranty repairs were:
Sales
Actual warranty repairs
2014
5,000,000
200,000
2015
9,000,000
560,000
Required:
1. Prepare journal entries in connection with the warranty using the "expense as incurred"
approach.
2. Prepare journal entries in connection with the warranty using the "accrual" approach.
3. Determine the estimated warranty liability on December 31,2015.
4. Analyze the estimated warranty liability account to ascertain if adjustment is necessary.
The sales and warranty repairs are made evenly during the year.
5. Prepare the adjustment to correct the estimated warranty liability on December 31, 2015.
67. In 2014, Plumpton Company started selling new computer that carried a 2-year warranty
against defects. Based on the manufacturer's recommendations, the entity estimated
warranty cost as a percentage of sales as follows:
First year of warranty
3%
Second year of warranty
9%
MCQ – Straight Problems
Page 44
Provisions & Contingencies
Sales and actual warranty repairs are as follows:
Sales
Actual warranty repairs
2014
5,000,000
100,000
2015
7,000,000
250,000
Required:
1. Prepare journal entries to record the transactions for 2014 and 2015.
2. Analyze the estimated warranty liability account on December 31, 2015 to ascertain if
the actual repairs approximate the estimate. The sales and repairs occur evenly
throughout the year.
3. Prepare the adjustment of the estimated warranty liability on December 31, 2015.
68. Sony Company sells stereos under a 2-year warranty contract that requires the entity to
replace defective parts and provide free labor on all repairs.
During 2013, 1,000 units were sold at P9,000 each. In 2014, the entity sold an additional 900
units at P9,250 each. Sales occurred on the last day of the year for both 2013 and 2014.
Based on past experience, the estimated 2-year warranty costs are P200 for parts and P250
for labor per unit. It is also estimated that 40% of the warranty expenditures will occur in the
first year and 60% in the second year. Actual warranty expenditures were as follows:
2014
2015
Stereos sold in 2013
180,000
280,000
Stereos sold in 2014
190,000
Required:
1. Prepare journal entries for 2013, 2014 and 2015.
2. Analyze the estimated warranty liability account to prove the reasonable accuracy of the
balance.
3. Prepare the adjustment of the estimated warranty liability on December 31, 2015.
69. Dawson Company manufactures television components and sells them with a 6-month
warranty under which defective components will be replaced without charge. On January 1,
2014, the warranty liability had a balance of P620,000. By June 30, 2014, this balance had
been reduced to Pl20,400 by debits for estimated net cost of components returned that had
been sold in 2013.
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FINANCIAL ACCOUNTING
The entity started out in 2014 expecting 7% of sales to be returned. However, due to the
introduction of new models during the year, this estimated percentage of returns was
increased to 10% on May 1. It is assumed that no components sold during a given month are
returned in that month. Each component is stamped with a date at time of sale so that the
warranty may be properly administered.
The following table of percentages indicates the likely pattern of sales returns during the 6month period of the warranty, starting with the month following the sale of components.
Percentage of total
Month following sale
returns expected
First
30%
Second
20
Third
20
Fourth through sixth - 10% each month
30
100%
Gross sales of components were as follows for the first six months of 2014:
Month
Amount
Month
Amount
January
4,200,000
April
3,250,000
February
4,700,000
May
2,400,000
March
3,900,000
June
1,900,000
The warranty also covers the payment of freight cost on defective components returned and
on the new components sent out as replacements. This freight cost runs approximately 5%
of the sales price of the components returned.
The manufacturing cost of the components is roughly 70% of sales price, and the salvage
value of returned components averages 10% of their sales price.
Returned components on hand on January 1, 2014, were thus valued in inventory at 10% of
their original sales price.
Required:
1. Determine the estimated sales returns subsequent to June 30, 2014.
2. Determine the required estimated warranty liability on June 30, 2014.
3. Prepare the adjustment of the estimated warranty liability on June 30, 2014.
MCQ – Straight Problems
Page 46
Provisions & Contingencies
70. Precise Company sells an electric timer that carries a 90-day unconditional warranty against
product failure. Based on a reliable statistical analysis, 2% of units sold will require an
average cost of P150 per unit.
Units sold
Known product failures from sales of:
October
November
December
October
32,000
160
80
180
-
November
28,000
December
40,000
320
280
160
Required:
Prepare a journal entry to record the estimated liability for warranty on December 31. The
warranty costs of known failures have already been reflected in the records.
71. Anneliese Company sells televisions at an average price of P9,000 and also offers a separate
three-year warranty contract for P900 that requires the entity to perform periodic services and
replace defective parts. During 2014, the entity sold 300 television sets and 270 extended
warranty contracts for cash. The entity estimated the three-year warranty cost as P200 for
parts and P400 for labor and accounts for the sale of warranty separately.
The sale occurred on December 31, 2014. The entity recognizes income from the sale of
warranty on a straight line basis. In 2015, the entity incurred actual cost relative to the
warranty of P20,000 for parts and P40,000 for labor.
Required:
1. Prepare journal entries in 2014 and 2015.
2. How is the unearned revenue from warranty contracts presented on December 31,
2015?
Environmental provision
72. Prime Company provided the following information for the current year:

Prime Company has long owned a manufacturing site that has now been discovered to
be contaminated with toxic waste. The entity has acknowledged its responsibility for the
contamination. An initial clean up feasibility study has shown that it will cost at least
P500,000 to clean up the toxic waste.
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FINANCIAL ACCOUNTING

Prime Company has been sued for patent infringement and lost the case. A preliminary
judgment of P300,000 was issued and is under appeal. The entity's attorneys agree that
it is probable that the entity will lose this appeal.
Required:
Prepare journal entries to recognize any provision at the end of current year.
Restructuring provision
73. Troy Company decided on November 1, 2014 to restructure the entity's operations.
* Mindanao Branch would be closed down to concentrate on Manila operations.
* 200 employees working in Mindanao Branch would be retrenched on November 30,
2014, and would be paid their accumulated entitlements plus three months' wages.
* The remaining 50 employees working in Mindanao Branch would be transferred to
Manila, which would continue operating.
* Five executives would be retrenched on December 31, 2014, and would be paid their
accumulated entitlements plus three months' wages.
On December 31, 2014, the following transactions and events had occurred:
* Mindanao Branch was shut down on November 30, 2014.
* The 200 retrenched employees have left and their accumulated entitlements have been
paid. However, an amount of PI,500,000, representing a portion of the three months'
wages for the retrenched employees, has still not been paid.
* Costs of P400,000 were expected to be incurred in transferring the 50 employees to their
new work in Manila. The transfer is planned for January 15, 2015.
* Four of the five executives who have been retrenched have had their accumulated
entitlements paid, including the three months' wages. However, one remains in order to
complete administrative tasks relating to the closure of Mindanao Branch and the
transfer of staff to Manila. This executive is expected to stay until January 31, 2015. His
salary for January will be P50,000 and his retrenchment package will be P200,000, all
of which will be paid on the day he leaves. He estimates that he would spend 60% of his
time administering the closure of Mindanao Branch, 30% on administering the transfer
of staff to Manila, and the remaining 10% on general administration.
Required:
1. Determine the provision for restructuring on December 31,2014.
2. Prepare journal entry to record the provision for restructuring.
MCQ – Straight Problems
Page 48
Provisions & Contingencies
74. Anneliese Company is involved in a restructuring related to its toy division. The controller and
chief finance officer are considering the following costs to accrue as part of the restructuring.
The entity has a long-term lease on one of the facilities related to the division. It is estimated
that it will have to pay a penalty of P4,000,000 to break the lease. The entity estimates that
the present value related to payment on the lease contract is P6,500,000.
The entity's allocation of overhead costs to other divisions will increase by P15,000,000 due
to the restructuring of the facilities.
Also, some employees will be shifted to other divisions within the entity and cost of retraining
the employees is estimated atP20,000,000.
The entity has hired an outplacement firm to help in dealing with the number of terminations
related to the restructuring. It is estimated that the cost to the entity will be P6,000,000.
Employee termination costs are estimated to be P30,000,000 and the entity believes that
moving usable assets from the toy division to other division within the entity will cost
P3,200,000.
Required:
Compute the total amount that should be included in restructuring provision. '
Decommissioning provision
75. On January 1, 2014, Petron Company purchased on oil tanker depot at a cost of P6,000,000.
The entity is expected to operate the depot for 5 years after which it is legally required to
dismantle the depot and remove the underground storage tanks. The oil tanker depot is
depreciated using straight line with no residual value.
It is reliably estimated that the cost of decommissioning the depot will amount to PI,500,000.
The appropriate discount rate is 10%. The present value of 1 at 10% for 5
periods is 0.62.
On December 31, 2018, after 5 years of operating the depot, the entity paid a demolition
entity to dismantle the depot at a price of Pl,700,000.
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FINANCIAL ACCOUNTING
Required:
1. Prepare journal entries in 2014 in relation to the depot and the decommissioning liability.
2. Prepare journal entries to record the derecognition of the depot and the settlement of the
decommissioning liability on December 31, 2018.
76. On January 1, 2014, Stanford Company purchased a mining site that will have to be restored
to certain specifications when the mining production ceases. The cost of the mining site is
P8,000,000 and the restoration cost is expected to be P2,000,000. It is estimated that the
mine will continue in operation for 10 years.
The appropriate discount rate is 8%. The present value of 1 at 8% for 10 periods is 0.4632.
On December 31, 2023, the entity contracted with another entity for the restoration of the
mining site in accordance with specifications at a cost of Pl,800,000.
Required:
1. Prepare journal entries in 2014 to record the purchase of the mining site and the
recognition of the decommissioning liability.
2. Prepare journal entry to record the settlement of the decommissioning liability on
December 31, 2023.
77. On January 1, 2014, Camille Company purchased a gas detoxification facility for P9,000,000.
The cost of cleaning up the routine contamination caused by the initial location of gas on the
property is estimated to be PI,500,000. This cost will be incurred in 10 years when all of the
existing stockpile of gas is detoxified and the facility is decommissioned.
Additional contamination may occur in succeeding years that the facility is in operation. On
January 1, 2016, additional contamination clean up cost is estimated at P200,000. The
appropriate discount rate is 6%. The present value of 1 at 6% is 0.63 for 8 periods and 0.56
for 10 periods.
On December 31, 2023, the entity paid a contractor an amount of P2,000,000 for the
decommissioning of the detoxification facility.
MCQ – Straight Problems
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Provisions & Contingencies
Required:
1. Prepare journal entries in 2014 in relation to the detoxification facility and the
decommissioning liability.
2. Prepare journal entries in 2016 in relation to the detoxification facility and
decommissioning liability.
3. Prepare journal entries on December 31, 2023 to record the derecognition of the
detoxification facility and the settlement of the decommissioning liability.
Lawsuits
78. Sunrise Company has several contingent liabilities on December 31, 2014. A brief description
of each liability is as follows:
 A personal injury liability suit for P500,000 was brought against Sunrise Company in
March2014. The management and legal counsel of Sunrise Company concluded that it
is not probable that Sunrise Company will be responsible for damages and that P150,000
is the best estimate of the damages.
 In July 2014, Sunrise Company became involved in a tax dispute with the BIR pertaining
to 2013 income tax. In December 2014, a judgment for P400,000 was assessed against
Sunrise Company by the tax court. Sunrise Company is appealing the amount of the
judgment. The tax advisor and legal counsel of Sunrise Company believed it is probable
that the assessment can be reduced on appeal by 50%.
 Sunrise Company signed as guarantor for P200,000 loan by PNB to Sunset Company,
a principal supplier of Sunrise. By reason of financial difficulties, it is probable that
Sunrise Company shall pay the P200,000 loan with only a 60% recovery anticipated from
Sunset Company.
Required:
Prepare journal entries to recognize any provision on December 31, 2014.
79. A Singapore-based shipping entity lost an entire shipload of cargo valued at P5,000,000 on
a voyage to Australia. It is however covered by an insurance policy. According to the report
of the investigator, the amount is collectible, subject to the deductible clause in the insurance
policy.
Before year-end, the shipping entity received a letter from the insurance entity that a check
was in the mail for 90% of the claim.
The international freight forwarding entity that entrusted the shipping entity with the delivery
of the cargo overseas has filed a lawsuit for P5,000,000 claiming the value of the cargo that
was lost on high seas, and also consequential damages of P2,000,000 resulting from the
delay.
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FINANCIAL ACCOUNTING
According to the legal counsel for the shipping entity, it is probable that the shipping entity
would have to pay the P5,000,000, but it is a remote possibility that it would have to pay the
additional P2,000,000 claimed by the international freight forwarding entity, since this loss
was specifically excluded in the freight forwarding contract.
Required:
Determine the amount of provision at year-end. Explain fully your answer.
Deferred revenue, Lawsuits
80. Star Company, a publisher, is preparing the 2014 financial statements and must determine
the proper accounting treatment for each of the following situations:
* Star Company sells subscriptions to several magazines for a one-year, two-year, or
three-year period. Cash receipts from subscribers are credited to unearned subscription
revenue.
The unearned subscription revenue account has a balance of P3,000,000 on December
31, 2014. Outstanding subscriptions on December 31, 2014 expire as follows:
During 2015
800,000
During 2016
1,000,000
During 2017
500,000
* An author filed a suit for breach of contract seeking damages of P2,000,000 against Star
Company on July 1, 2014. The entity's legal counsel believes that an unfavorable
outcome is probable.
The best estimate of the court's award to the plaintiff is Pl,500,000.
* During December 2014, a competitor filed suit against Star Company for industrial
espionage, claiming P3,000,000 in damages. Management and legal counsel believe it
is probable that damages will be awarded to the plaintiff and the best estimate of the
damages is PI,000,000.
Required:
Prepare journal entries to record the transactions and events. If you believe that no entry is
required, explain your answer.
MCQ – Straight Problems
Page 52
Provisions & Contingencies
Environmental provision, lawsuits
81. Eastern Company has several contingent liabilities on December 31, 2014. The auditor
obtained the following brief description of each liability:
* In May 2014, Eastern Company became involved in litigation. In December 2014, the
court assessed a judgment for PI,600,000 against Eastern Company. The entity is
appealing the amount of the judgment. The attorneys believed it is probable that the
assessment can be reduced on appeal by 50%. The appeal is expected to take at least
a year.
* In July 2014, Pasig City brought action against Eastern Company for polluting the Pasig
River with its waste products. It is probable that Pasig City will be successful but the
amount of damages the entity might have to pay should not exceed Pl,500,000.
* Eastern Company has signed as guarantor for a P1,000,000 loan by First Bank to
Northern Company, a principal supplier to Eastern Company. At this time, there is a only
a remote likelihood that Eastern Company will have to make payment on behalf of
Northern Company.
Required:
Prepare journal entries to recognize any provision on December 31, 2014.
Miscellaneous
82. Iriga Company issued the 2014 financial statements on March 1, 2015. The entity provided
the following data for the year ended December 31, 2014:
Amount owing to another entity for services rendered during December 2014
300,000
Estimated long service leave owing to employees in respect of past services 1,200,000
Estimated cost of relocating an employee from head office to a
branch in another city (employee will physically relocate January 2015)
100,000
Estimated cost of overhauling machine every 5 years (the machine is
5 years old on December 31, 2014)
150,000
Required:
1. Determine the amount of provision to be recognized on December 31, 2014.
2. Explain the treatment of the other items not included in provision.
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FINANCIAL ACCOUNTING
83. The audit of Anne Company for the year ended December 31, 2014 was completed on March
1, 2015.
The financial statements were signed by the managing director on March 15, 2015 and
approved by the shareholders on March 31, 2015. The next events have occurred.
*
*
On January 15, 2015, a customer owing P900,000 to Anne Company filed for
bankruptcy. The financial statements include an allowance for doubtful accounts
pertaining to this customer only of P100,000.
Specialized equipment costing P525,000 purchased on September 1, 2014 was
destroyed by fire on December 15, 2014. Anne Company has booked a receivable of
P400,000 from the insurance entity. After the insurance entity completed the
investigation on February 1, 2015, it was discovered that the fire took place due to
negligence of the machine operator. As a result, the insurer's liability was zero on this
claim.
Required:
Prepare adjusting entries on December 31, 2014 to recognize the events after reporting
period.
84. Norway Company prepared the financial statements on December 31, 2014 and the financial
statements are authorized for issue on March 15, 2015.
*
On December 31, 2014, Norway Company had a receivable of P400,000 from a
customer that is due 60 days after the end of reporting period.
On January 15, 2015, a receiver was appointed for the said customer. The receiver
informed Norway Company that the P400,000 would be paid in full by June 30, 2015.
*
Norway Company had reported a contingent liability on December 31, 2014 related to a
court case in which Norway Company was the defendant. The case was not heard until
the first week of February 2015.
On February 11, 2015, the judge handed down a decision against Norway Company.
The judge determined that Norway Company was liable to pay damages and costs
totaling P3,000,000.
*
On December 31, 2014, Norway Company had a receivable from a large customer in
the amount of P3,500,000.
MCQ – Straight Problems
Page 54
Provisions & Contingencies
On January 31, 2015, Norway Company was advised by the liquidator of the said
customer that the customer was insolvent and would be unable to repay the full amount
owed to Norway Company.
The liquidator advised Norway Company in writing that only 10% of the receivable will
be paid on April 30, 2015.
Required:
Prepare adjusting entries on December 31, 2014 to record the events after the reporting
period.
MCQ – Straight Problems
Page 55
FINANCIAL ACCOUNTING
ANSWER KEY THEORY
1.A
2.D
3.C
4.B
5.C
6.C
7.A
8.B
9.D
10.C
11.C
12.B
13.A
14.C
15.C
16.A
17.D
18.C
19.D
20.A
21.C
22.C
23.A
24.B
25.A
26.D
27.D
28.D
29.C
30.D
Answer Key
31.D
32.D
33.B
34.D
35.D
36.C
37.A
38.D
39.A
40.C
41.B
42.D
43.B
44.B
45.C
46.B
47.A
48.B
49.A
50.C
51.D
52.B
53.A
54.B
55.C
56.A
57.B
58.C
59.D
60.A
PROBLEMS
61.D
62.B
63.B
64.A
65.B
66.B
67.C
68.A
69.A
70.B
71.B
72.B
73.D
74.D
1.A
2.B
3.A
4.B
5.C
6.B
7.A
8.A
9.C
10.B
11.B
12.C
13.D
14.C
15.D
16.D
17.A
18.B
19.C
20.A
21.D
22.D
23.C
24.D
25.D
26.D
27.B
28.C
29.A
30.B
31.A
32.C
33.A
34.C
35.C
36.D
37.C
38.B
39.B
40.A
41.C
42.C
43.A
44.A
45.D
46.D
47.C
48.A
49.A
50.A
51.B
52.B
53.C
54.A
55.C
56.B
57.A
58.B
59.B
Page 56
Provisions & Contingencies
ANSWER EXPLANATION
1.
Answer is (A).
Long term service leave = 1,200,000
A provision is a present obligation that is uncertain in amount or timing. The present obligation
must be both probable and measurable.
The amount owing to another entity is a present obligation but technically it is not a provision
because the amount is certain. Of course, it is an accrued liability.
The estimated cost of relocating the employee is a future cost because it is to be incurred in
January 2014. Thus, it is not included in December 31,2013 provision.
The estimated cost of overhaul is not a provision because there is no present obligation. The
entity may decide to sell the machine or not to repair it.
2.
Answer is (B).
Premiums distributed in 2015
Estimated premiums in 2015
Total
Less: Estimated premiums in 2014
Premiums applicable to 2015
Premium expense
(5,800 x 60)
5,500
500
6,000
200
5,800
348,000
3.
Answer is (A).
Premium distributed in 2015
Premiums to be distributed in 2016
Total
Premiums arising from 2014 sales distributed in 2015
Premiums applicable to 2015
Premium expense
(48,000 x 40)
50,000
3,000
53,000
(5,000)
48,000
1,920,000
4.
Answer is (B).
Coupons to be redeemed
Less: coupons redeemed
Balance
Number of premiums
Amount of liability
Answer Explanation & Solutions
(160,000 x 60%)
(56,000 / 5)
(11,200 x 20)
96,000
40,000
56,000
11,200
224,000
Page 57
FINANCIAL ACCOUNTING
5.
Answer is (C).
Premiums to be distributed
Premiums distributed
Balance
Premium liability
(250,000 x 80% / 10)
(5,000 x 100)
20,000
15,000
5,000
500,000
6.
Answer is (B).
Boxtops to be redeemed
(675,000 x 60%)
405,000
Boxtops redeemed
(330,000)
Boxtops outstanding
75,000
Estimated liability – December 31, 2014
(75,000 / 3 x 15) 375,000
7.
Answer is (A).
Beermugs to be distributed
(50% x 300,000 / 20)
Beermugs already distributed
Beermugs outstanding
Estimated liability – December 31, 2014
(45 x 3,000)
8.
9.
Answer is (A).
Basketballs to be distributed
Basketballs distributed
Balance
Multiply by cost of basketball
Estimated liability
(100,000 x 60% / 10)
(4,125,000 / 5,500)
Answer is (C).
Coupons to be redeemed in 2014 and 2015
(1,300,000 x 30%)
Coupons redeemed in 2014 & 2015
(140,000 + 200,000)
Outstanding coupons – 12/31/2015
Divide by
Number of towels
Multiply by cost of towels minus remittance
(100 – 20)
Estimated liability – 12/31/2015
10. Answer is (B).
Coupons to be redeemed
(400,000 x 60%)
Coupons redeemed
Coupons outstanding
Estimated liability – December 31, 2014(140,000 / 5 x P50)
Answer Explanation & Solutions
7,500
4,500
3,000
135,000
6,000
4,000
2,000
750
1,500,000
390,000
340,000
50,000
10
5,000
80
400,000
240,000
(100,000)
140,000
1,400,000
Page 58
Provisions & Contingencies
11. Answer is (B).
Coupons to be redeemed
Less: Coupons redeemed
Coupon outstanding
Liability for unredeemed coupons
(80% x 500,0000)
(100,000 x 15)
12. Answer is (C).
Total coupons issued and to be redeemed (600,000 x 70% x 110%)
Less: Total payments to retailer
Liability for redeemed coupons – 12/31/2014
400,000
300,000
100,000
1,500,000
462,000
220,000
242,000
13. Answer is (D).
Coupons expected to be redeemed
12,000
Multiply by payment for each coupon
(45 + 5)
50
Total liability for coupons
600,000
Payments as of December 31, 2014
(250,000)
Liability for coupons, December 31, 2014
350,000
The coupon liability on December 31, 2014 is not reduced by the 5,000 coupons on hand
because the coupons had not been processed for payment.
14. Answer is (C).
Rebate expense
Rebates redeemed
Liability for rebates
(6,000,000 x 10% x 10)
(210,000 x 10)
6,000,000
(2,100,000)
3,900,000
15. Answer is (D).
Warranty expense
(2,400 x 300)
720,000
16. Answer is (D).
Warranty expense
(5% x 5,000,000)
250,000
17. Answer is (A).
Warranty expense
(1% x 5,000,000)
50,000
(3% x P5,000,000)
(5% x P3,000,000)
150,000
150,000
300,000
18. Answer is (C).
Major defect
Minor defect
Total warranty provision
Answer Explanation & Solutions
Page 59
FINANCIAL ACCOUNTING
19. Answer is (C).
Normal defect
Significant defect
Warranty provision
(500 x P10,000 x 25%)
(500 x P30,000 x 15%)
20. Answer is (A).
Minor repairs
(3% x 10,000,000 = 300,000 x 10%)
Major repairs
(2% x 10,000,000 = 200,000 x 90%)
Weighted probabilities
Multiply by risk adjustment factor (6% increase)
Adjusted cash flows
Paid in 2013
(50%)
Balance - December 31,2013
Multiply by PV factor
Warranty provision - December 31,2013
21. Answer is (D).
2013
Warranty expense
Warranty liability
2014
Warranty liability
Finance cost
Warranty expense
Cash
50,000
Weighted probabilities:
5% x 400,000
20% x 200,000
50% x 80,000
25% x 20,000
Expected cash flows
Answer Explanation & Solutions
30,000
180,000
210,000
1.06
222,600
(111,300)
111,300
.95
105,735
50,000
50,000
2,000
88,000
140,000
Warranty expense related to 2014 sales
Warranty expense related to 2013 sales
Total warranty expense
Warranty expense
Warranty liability
1,250,000
2,250,000
3,500,000
107,730
(60,000 - 52,000)
80,000
8,000
88,000
107,730
20,000
40,000
40,000
5,000
105,000
Page 60
Provisions & Contingencies
Multiply by risk adjustment factor (100% + 8%)
Adjusted cash flows
Multiply by PV of 1 at 10% for 6 months
Present value of cash flows
1.08
113,400
.95
107,730
Warranty cost paid related to 2014 sales
Warranty liability related to 2014 sales
Total warranty expense in 2014
22. Answer is (D).
Net sales
88,000
107,730
195,730
(640,000 / 8%)
8,000,000
(3,000 x 80)
240,000
70,000
170,000
23. Answer is (C).
Warranty expense
Less: Actual warranty cost
Warranty liability – June 30, 2014
24. Answer is (D).
Warranty liability – January 1, 2014
Add: Warranty expense 2014
(2% x 4,000,000)
Total
Less: Warranty payments during 2014
Warranty liability – December 31, 2014
60,000
80,000
140,000
50,000
90,000
25. Answer is (D).
Estimated warranty liability – January 1, 2014
Warranty expense
5,000 x 200)
Actual warranty expenditures
Estimated warranty liability – December 31, 2014
650,000
1,000,000
(750,000)
900,000
26. Answer is (D).
Warranty expense:
2014
(6% x 6,000,000)
2015
(6% x 10,000,000)
Actual warranty expenditures:
2014
2015
Warranty liability – December 31, 2014
Answer Explanation & Solutions
360,000
600,000
90,000
300,000
960,000
390,000
570,000
Page 61
FINANCIAL ACCOUNTING
27. Answer is (B).
Warranty expense:
2014
(7% x 5,000,000)
2015
(7% x 7,000,000)
Actual warranty expenditures:
2014
2015
Warranty liability – December 31, 2014
28. Answer is (C).
Depreciation expense
Interest expense
350,000
490,000
100,000
300,000
(5,000,000 + 385,000) / 10
385,000 x 10%
840,000
400,000
440,000
538,500
38,500
29. Answer is (A).
Unpaid wages of retrenched employees
1,000,000
Retrenchment package of Juan Cruz
150,000
Salary for administering closure of Factory A
(60% x P50.000)
30,000
Total restructuring provision
1,180,000
The amount of restructuring provision includes only direct expenditures arising from
restructuring and not associated with the ongoing activities of the entity. For example, salaries
and benefits of employees to be incurred after operations cease and that are associated with
the closure of the operations are included in the restructuring provision.
The payment of P300,000 to be incurred in transferring the remaining employees to Factory
B is not included in the restructuring provision because it relates to continuing staff as part of
ongoing activities.
The restructuring provision does not include cost of retraining or relocating continuing staff,
and marketing or advertising program because these relate to ongoing activities of the entity.
30. Answer is (B).
Cost for shipping goods
Airfare
Temporary accommodation cost for May and June
Reimbursement for lease break cost
Reimbursement for cost of living increases for May & June (120,000 x 2/12)
Total provision for relocation costs
30,000
10,000
80,000
20,000
20,000
160,000
31. Answer is (A). The guarantee should be accrued as a provision because the loss is probable
and the amount can be reasonably estimated.
Answer Explanation & Solutions
Page 62
Provisions & Contingencies
32. Answer is (C).
Expense
Liability
580,000
580,000
33. Answer is (A). The loss is accrued as a provision because it is probable and they amount
can be reasonably estimated.
34. Answer is (C). The loss on the first lawsuit is both probable and measurable and therefore
can be accrued as a provision.
35. Answer is (C). Accrue the most probable cost of P3,600,000 and disclose the additional
contingency of 2,400,000 (6,000,000 – 3,600,000).
36. Answer is (D). The probable loss is recorded but the possible loss is only disclosed.
37. Answer is (C).
Estimated liability for lawsuit 5,000,000
The lawsuit claim of P5,000,000 is recognized as a provision because it is both probable and
measurable. However, the additional claim of P2,000,000 is not recognized because it is
remote.
38. Answer is (B).
Weighted probabilities
20% x 200,000 x 70%
80% x 100,000 x 70%
Weighted cash flows
Multiply by risk adjustment factor
Adjusted cash flows
Multiple by PV of 1 at 5% for one period
Present value of cash flows
39. Answer is (B).
Weighted probabilities
60% x 2,000,000 x 80%
40% x 1,000,000 x 80%
Weighted cash flows
Multiply by risk adjustment factor
Adjusted cash flows
Multiple by PV of 1 at 12% for one period
Present value of cash flows
Answer Explanation & Solutions
(100% + 7%)
28,000
56,000
84,000
1.07
89,880
0.95
85,386
(100% + 8%)
960,000
320,000
1,280,000
1.08
1,382,400
0.89
1,230,336
Page 63
FINANCIAL ACCOUNTING
40. Answer is (A).
Weighted probabilities:
60% x 2,000,000 x 80%
40% x 1,000,000 x 80%
Expected cash flows
Multiply by risk adjustment factor
Adjusted cash flows
Multiply by PV of 1 at 10% for one period
Present value of cash flows
(100% + 7%)
960,000
320,000
1,280,000
1.07
1,369,600
0.91
1,246,336
41. Answer is (C). The provision should be accrued because it is probable and measurable. The
accrued amount is P350,000 which is the midpoint of the range in the absence of the best
estimate within the range.
42. Answer is (C).
Midpoint of the range (200,000 + 450,000 / 2)
325,000
43. Answer is (A). The loss is accrued as a provision because it is probable and measurable.
The accrued amount is P500,000 only because it is the extent of liability of Rex under the
comprehensive insurance policy.
44. Answer A. Reasonably possible contingent liability is disclosed only.
45. Answer is (D).
The entry on December 31, 2013 is:
Loss on lawsuit
Estimated liability for lawsuit
The entry on December 31, 2014 is
Estimated liability for lawsuit
Cash
Copyright
Gain on settlement
400,000
400,000
400,000
250,000
60,000
90,000
46. Answer is D).
Environmental cost
500,000
Litigation cost
300,000
Total accrued liability
800,000
Both are accrued as provision because the loss is probable and measurable.
Answer Explanation & Solutions
Page 64
Provisions & Contingencies
47. Answer is (C).
Assessment on appeal
Environmental cost
Total provision
(50% x 1,600,000)
800,000
1,500,000
2,300,000
48. Answer is (A). Haze can report a gain of P1,500,000 in its 2014 income statement because
this amount is already settled on December 31, 2014. However, the remainder of P3,000,000
is only disclosed because the defendant has appealed the said amount.
49. Answer is (A). Final outcome of the case was awaiting appeal and still uncertain.
50. Answer is (A). Contingent assets are not recognized in financial statements since this may
result in the recognition of income that may never be realized. A contingent asset and the
related contingent gain are disclosed only where the inflow of economic benefits is probable.
51. Answer is (B). The contingent asset is disclosed only because the case is unresolved on
December 31, 2014. The issue is what amount of asset will be disclosed. Since the case is
settled in March 2015 after the issuance of the 2014 financial statements, the amount of
P1,500,000 should be disclosed. However, if the case is settled before the issuance of the
statements, the actual award of P1,000,000 should be disclosed.
52. Answer is (B).
Actual liability
Provision already recognized
Increase in liability
2,800,000
2,000,000
800,000
53. Answer is (C). The decision of the Supreme Court made on February 15, 2015 which is
before the issuance of the statements on February 20, 2015. Accordingly, the accrued
provision should be equal to the amount of P3,500,000 decided by the Supreme Court. The
date of issue of financial statements is the date when the board of directors approved the
financial statements.
54. Answer is (A).
Contractual profit share payment
350,000
Bad debt loss
340,000
Total adjusting events
690,000
The dividend is recognized on the date of declaration on March 15, 2015 and therefore a
non-adjusting event on December 31, 2014. The fire loss is also a non-adjusting event on
December 31, 2014 because it occurred on March 20, 2015.
Answer Explanation & Solutions
Page 65
FINANCIAL ACCOUNTING
55. Answer is (C). The profit remains at P9,000,000. The fire occurring on January 5, 2015 is a
non-adjusting event on December 31, 2014.
56. Answer is (B). The best estimate is recorded. The accepted BIR offer is not recorded
because it was made after the statements are issued.
57. Answer is (A).
58. Answer is (B). The entire amount of the note payable is classified as noncurrent liability.
PAS 1, paragraph 73, provides that if an entity has the discretion to refinance or roll over an
obligation for at least twelve months after the end of the reporting period, it shall classify the
obligation as noncurrent, even if it would otherwise be due within a shorter period.
59. Answer is (B).
Accounts payable
Unearned rent revenue
Estimated liability under warranties
Bonds payable
Discount on bonds payable
Total liabilities
60. 2014 Journal entries
Cash
Sales
1,000,000
300.000
250,000
5,000,000
(500,000)
6,050,000
3,600,000
3,600,000
Premiums
Cash
390,000
Cash (5,000 x 10)
Premium expense (5,000 x 40)
Premiums (5,000 x 50)
50,000
200,000
Premium expense (5,000 x 20)
Cash
100,000
Premium expense (2,000 x 60)
Estimated premium liability
120,000
Answer Explanation & Solutions
390,000
250,000
100,000
120,000
Page 66
Provisions & Contingencies
2015 Journal entries
Estimated premium liability
Premium expense
Reversing entry
120,000
Cash
Sales
4,200,000
Premiums
Cash
580,000
Cash (9,000 x 10)
Premium expense (9,000 x 40)
Premiums (9,000 x 50)
90,000
360,000
Premium expense (9,000 x 20)
Cash
180,000
Premium expense (3,000 x 60)
Estimated premium liability
180,000
61. Journal entries
Cash (400,000 x 9)
Sales
Premiums
Cash
Premium expense
Cash
4,200,000
580,000
450,000
180,000
180,000
3,600,000
3,600,000
900,000
30,000
Cash (8,000 x 5)
Premium expense (8,000 x 85)
Premiums
40,000
680,000
Premium expense (2,000 x 85)
Estimated premium liability
170,000
Answer Explanation & Solutions
120,000
900,000
30,000
720,000
170,000
Page 67
FINANCIAL ACCOUNTING
Bottle caps to be redeemed
Less: bottle caps redeemed
Bottle caps outstanding
(25% x 400,000)
(8,000 pens x 10)
Premiums to be distributed on the balance of bottle caps (20,000 x 10)
Premiums
Cash
62. Requirement 1:
2014 1. Cash
Sales
2. Premiums – towels
Cash
3. Cash (1,000 x 20)
Premium expense
Premiums – towels (1,000 x 100)
4. Premium expense (1,000 x 5)
Cash
2015
150,000
150,000
2,500,000
175,000
20,000
80,000
5,000
51,000
1. Estimated premium liability
Premium expense
51,000
175,000
100,000
5,000
51,000
3,125,000
2. Premiums – towels
Cash
200,000
3. Cash (1,800 x 20)
Premium expense
Premiums – towels (1,800 x 100)
36,000
144,000
Answer Explanation & Solutions
2,000
2,500,000
5. Premium expense
Estimated premium liability (600 x 85)
Cash
Sales
100,000
80,000
20,000
51,000
3,125,000
200,000
180,000
Page 68
Provisions & Contingencies
4. Premium expense (1,800 x 5)
Cash
9,000
9,000
5. Premium expense
Estimated premium liability (800 x 85)
Requirement 2: Statement Classification
Current asset:
Premiums – towels
Current liabilities
Estimated premium liability
Selling expense:
Premium expense
63. Journal entries
2014 Cash
Sales
Unearned revenue – points
Unearned revenue - points
Sales
Points to be redeemed
Revenue to be recognized in 2014
2015
Unearned revenue – points
Sales
68,000
2013
2014
75,000
95,000
51,000
68,000
136,000
170,000
9,000,000
7,000,000
2,000,000
750,000
(80% x 50,000)
(15,000/40,000 x 2,000,000)
330,000
Points to be redeemed
(85% x 50,000)
Total points redeemed to 12/31/2015 (22,950/42,500 x 2,000,000)
Revenue recognized in 2014
Revenue to be recognized in 2015
2016
Unearned revenue – points
Sales
Answer Explanation & Solutions
68,000
120,000
750,000
40,000
750,000
330,000
42,500
1,080,000
(750,000)
330,000
120,000
Page 69
FINANCIAL ACCOUNTING
Points to be redeemed
(85% x 50,000)
42,500
Total points redeemed to 12/31/2016 (25,500/42,500 x 2,000,000) 1,200,000
Revenue recognized in 2015
(1,080,000)
Revenue to be recognized in 2016
120,000
2017
Unearned revenue – points
Sales
600,000
600,000
Points to be redeemed (90% x 50,000)
40,500
Total points redeemed to 12/31/2017
(15,000 + 7,950 + 2,550 + 15,000)
1,800,000
Cumulative revenue – 12/31/2017
(40,500/45,000 x 2,000,000) 1,200,000
Revenue recognized in 2016
(1,080,000)
Revenue to be recognized in 2017
600,000
64. Journal entries (The entity is the principal)
Cash
Sales
Revenue from points
Total consideration
Fair value of points
Fair value of initial sales
Loyalty program expense
Cash (5,000 x 50)
Journal entries (The entity is an agent of the airline)
Cash
Sales
Liability for points
Liability for points
Cash
Revenue from points
65. 1. “Expense as incurred” approach
2014 Cash
Sales
Answer Explanation & Solutions
5,000,000
4,700,000
300,000
(5,000 x 60)
250,000
5,000,000
5,000,000
300,000
4,700,000
250,000
4,700,000
300,000
300,000
250,000
50,000
4,500,000
4,500,000
Page 70
Provisions & Contingencies
Warranty expense
Cash
2015
40,000
40,000
Cash
Sales
7,500,000
Warranty expense
Cash
150,000
2. “Accrual” approach
2014 Cash (300 x 15,000)
Sales
2015
Cash (500 x 15,000)
Sales
150,000
4,500,000
4,500,000
Warranty expense
Estimated warranty liability (60% x 300 x 800)
Estimated warranty liability
Cash
7,500,000
144,000
144,000
40,000
40,000
7,500,000
7,500,000
Warranty expense
240,000
Estimated warranty liability (60% x 500 x 800)
240,000
Estimated warranty liability
Cash
150,000
3. Estimated warranty liability, 12/31/2015
Warranty expense
2014
2015
Actual warranty payments
2014
2015
Estimated warranty liability 12/31/2015
Answer Explanation & Solutions
150,000
144,000
240,000
40,000
150,000
384,000
190,000
194,000
Page 71
FINANCIAL ACCOUNTING
4. Warranty expense related to 2014 sales
2014 First contract year of 1/1/2014 sales
(150 x 20% x 800)
First contract year of 7/1/2014 sales (150 x 20% x 800 x 6/12)
24,000
12,000
2015
First contract year of 7/1/2014 sales (150 x 20% x 800 x 6/12)
Second contract year of 1/1/2014 sales
(150 x 40% x 800)
Second contract year of 7/1/2014 sales (150 x 40% x 800 x 6/12)
12,000
48,000
24,000
2016
Second contract year of 7/1/2014 sales (150 x 40% x 800 x 6/12)
Warranty expense
24,000
144,000
Warranty expense related to 2015 sales
2015 First contract year of 1/1/2015 sales
(250 x 20% x 800)
First contract year of 7/1/2015 sales (250 x 20% x 800 x 6/12)
40,000
20,000
2016
First contract year of 7/1/2015 sales (250 20% x 800 x 6/12)
Second contract year of 1/1/2015 sales
(250 x 40% x 800)
Second contract year of 7/1/2015 sales (250 x 40% x 800 x 6/12)
20,000
80,000
40,000
2017
Second contract year of 7/1/2015 sales (250 x 40% x 800 x 6/12)
Warranty expense
40,000
240,000
5.
2014 sales still under warranty after 12/31/2015:
Second contract year of 7/1/2014 sales
2015 sales still under warranty after 12/31/2015:
First contract year of 7/1/2015 sales
Second contract year of 1/1/2015 sales
Second contract year of 7/1/2015 sales (40,000 + 40,000)
Estimated warranty liability – 12/31/2015
Estimated warranty liability per book
Increase in warranty liability
Warranty expense
Estimated warranty liability
66. Requirement 1: “Expense” approach
2014
1. Cash
Sales
Answer Explanation & Solutions
24,000
20,000
80,000
80,000
204,000
194,000
10,000
10,000
10,000
5,000,000
5,000,000
Page 72
Provisions & Contingencies
2. Warranty expense
Cash
2015
1. Cash
Sales
2. Warranty expense
Cash
Requirement 2:
2014
1. Cash
Sales
2015
200,000
200,000
9,000,000
9,000,000
560,000
5,000,000
560,000
5,000,000
2. Warranty expense
700,000
Estimated warranty liability (14% x 5,000,0000)
700,000
3. Estimated warranty liability
Cash
200,000
1. Cash
Sales
200,000
9,000,000
2. Warranty expense
1,260,000
Estimated warranty liability (14% x 9,000,0000)
3. Estimated warranty liability
Cash
Requirement 3:
Warranty expense
2014
2015
Actual warranty repairs
2014
2015
Estimated warranty liability, 12/31/20115
Answer Explanation & Solutions
560,000
700,000
1,260,000
200,000
560,000
9,000,000
1,260,000
560,000
1,960,000
760,000
1,200,000
Page 73
FINANCIAL ACCOUNTING
Requirement 4: Warranty expense related to 2014 sales
2014 First contract year of 1/1/2014 sales
(2,500,000 x 4%)
First contract year of 7/1/2014 sales
(2,500,000 x 4% x 6/12)
2015 First contract year of 7/1/2014 sales
(2,500,000 x 4% x 6/12)
Second contract year of 1/12014 sales
(2,500,000 x 10%)
Second contract year of 7/12014 sales (2,500,000 x 10% x 6/12)
2016 Second contract year of 7/12014 sales (2,500,000 x 10% x 6/12)
Warranty expense
100,000
50,000
50,000
250,000
125,000
125,000
700,000
Requirement 5: Warranty expense related to 2015 sales
2015 First contract year of 7/1/2015 sales
(4,500,000 x 4%)
First contract year of 7/1/2015 sales
(4,500,000 x 4% x 6/12)
2016 First contract year of 7/1/2014 sales
(4,500,000 x 4% x 6/12)
Second contract year of 1/1/2015 sales
(4,500,000 x 10%)
Second contract year of 7/1/2015 sales (4,500,000 x 10% x 6/12)
2017 Second contract year of 7/1/2015 sales (4,500,000 x 10% x 6/12)
Warranty expense
180,000
90,000
90,000
450,000
225,000
225,000
1,260,000
2014 sales still under warranty after 12/31/2015:
Second contract year of 7/1/2014 sales
2015 sales still under warranty after 12/31/2015:
First contract year of 7/1/2015 sales
Second contract year of 1/1/2015
Second contract year of 7/1/2015 sales
Estimated warranty liability – 12/31/2015
Estimated warranty liability per book
Decrease in warranty liability
Estimated warranty liability
Warranty expense
67. Requirement 1:
2014
1. Cash
Sales
125,000
90,000
450,000
450,000
1,115,000
1,200,000
(85,000)
85,000
5,000,000
2. Warranty expense
600,000
Estimated warranty liability (12% x 5,000,0000)
Answer Explanation & Solutions
85,000
5,000,000
600,000
Page 74
Provisions & Contingencies
3. Estimated warranty liability
Cash
2015
1. Cash
Sales
100,000
100,000
7,000,000
7,000,000
2. Warranty expense
840,000
Estimated warranty liability (12% x 7,000,0000)
840,000
3. Estimated warranty liability
Cash
250,000
Requirement 2:
Warranty expense for 2014 & 2015
Actual warranty repairs
Estimated warranty liability – 12/31/2015
250,000
(600,000 + 840,000)
(100,000 + 250,000)
1,440,000
350,000
1,090,000
Warranty expense related to 2014 sales
2014 First contract year of 1/1/2014 sales
First contract year of 7/1/2014 sales
2015 First contract year of 7/1/2014 sales
Second contract year of 1/1/2014 sales
Second contract year of 7/1/2014 sales
2016 Second contract year of 7/1/2014 sales
Warranty expense for 2014
(2,500,000 x 3%)
(2,500,000 x 3% x 6/12)
(2,500,000 x 3% x 6/12)
(2,500,000 x 9%)
(2,500,000 x 9% x 6/12)
(2,500,000 x 9% x 6/12)
75,000
37,500
37,500
225,000
112,500
112,500
600,000
Warranty expense related to 2015 sales
2015 First contract year of 1/1/2015 sales
First contract year of 7/1/2015 sales
2016 First contract year of 7/1/2014 sales
Second contract year of 1/1/2015 sales
Second contract year of 7/1/2015 sales
2017 Second contract year of 7/1/2015 sales
Warranty expense for 2015
(3,500,000 x 3%)
(3,500,000 x 3% x 6/12)
(4,500,000 x 3% x 6/12)
(3,500,000 x 9%)
(3,500,000 x 9% x 6/12)
(3,500,000 x 9% x 6/12)
105,000
52,500
52,500
315,000
157,500
157,500
840,000
2014 sales still under warranty after 12/31/2015:
Second contract year of 7/1/2014 sales
2015 sales still under warranty after 12/31/2015:
First contract year of 7/1/2015 sales
Answer Explanation & Solutions
112,500
52,500
Page 75
FINANCIAL ACCOUNTING
Second contract year of 1/1/2015
Second contract year of 7/1/2015 sales
Estimated warranty liability – 12/31/2015
Estimated warranty liability per book
Decrease in warranty liability
315,000
315,000
795,000
1,090,000
(295,000)
Estimated warranty liability
Warranty expense
295,000
68. Requirement 1:
2013
1. Cash
Sales
9,000,000
9,000,000
2. Warranty expense
Estimated warranty liability (1,000 x 450)
2014
1. Cash
Sales
450,000
8,325,000
405,000
3. Estimated warranty liability
Cash
180,000
1. Estimated warranty liability (280,000 + 190,000) 470,000
Cash
Requirement 2:
Warranty expense related to 2013 sales
2014 First contract year of 12/31/2013 sales
(450,000 x 40%)
2015 Second contract year of 12/31/2014 sales
(450,000 x 60%)
Warranty expense related to 2014 sales
Answer Explanation & Solutions
405,000
180,000
2015
2013 sales still under warranty after 12/31/2015:
450,000
8,325,000
2. Warranty expense
Estimated warranty liability (900 x 450)
Warranty expense related to 2014 sales
2015 First contract year of 12/31/2014 sales
2016 Second contract year of 12/31/2014 sales
Warranty expense for 2014
295,000
(405,000 x 40%
(405,000 x 60%)
470,000
180,000
270,000
450,000
162,000
243,000
405,000
0
Page 76
Provisions & Contingencies
2014 sales still under warranty after 12/31/2015:
Second contract year of 12/31/2014
Estimated warranty liability – 12/31/2015
Estimated warranty liability per book
Decrease in warranty liability
243,000
243,000
205,000
(38,000)
Estimated warranty liability
Warranty expense
38,000
38,000
69. Requirement 1:
January
February
March
April
May
June
Sales
January
February
March
April
May
June
Sales
4,200,000
4,700,000
3,900,000
3,250,000
2,400,000
1,900,000
Jan
-
Feb
30%
-
Percent
7%
7%
7%
7%
10%
10%
Mar
20%
30%
-
Total
Returns
294,000
329,000
273,000
227,500
240,000
190,000
Apr
20%
20%
30%
-
May
10%
20%
20%
30%
-
Returns after
6/30/2014
10%
20%
30%
50%
70%
100%
June
10%
10%
20%
20%
30%
-
Total returns as of
6/30/2014
90%
80%
70%
50%
30%
-
Requirement 2:
Manufacturing cost
Freight
Total
Salvage value
Net loss on component returned
Required estimated warranty liability – 6/30/2014
Estimated warranty liability per book
Increase in warranty liability
Answer Explanation & Solutions
Amount
29,400
65,800
81,900
113,750
168,000
190,000
640,850
70%
5%
75%
(10%)
65%
(648,850 x 65%)
421,753
120,400
301,353
Page 77
FINANCIAL ACCOUNTING
Requirement 3:
Warranty expense
Estimated warranty liability
301,353
70. Journal entries:
Warranty expense
Estimated warranty liability
123,000
Units sold:
October
November
December
Total
Multiply by:
Total failures expected
Less: Failures already recorded:
October sales
November sales
December sales
Expected future failures
Multiply by
Estimated cost
71. Requirement 1:
2014 Cash
Sales
Unearned warranty revenue
2015
Unearned warranty revenue
Warranty revenue (243,000 / 3)
Warranty expense
Inventory
Cash
Requirement 2:
Current liabilities
Unearned warranty revenue
Noncurrent liabilities
Unearned warranty revenue
Answer Explanation & Solutions
301,353
123,000
32,000
28,000
40,000
100,000
2%
2,000
640
360
180
2,943,000
81,000
60,000
1,180
820
150
123,000
2,700,000
243,000
81,000
20,000
40,000
81,000
81,000
Page 78
Provisions & Contingencies
72. 1. Contamination clean up cost
Estimated liability for clean up cost
2. Loss on lawsuit
Estimated liability for lawsuit
500,000
300,000
500,000
300,000
73. 1. Unpaid entitlement of retrenched 200 employees
1,500,000
Unpaid retrenchment package of one executive tasked to
complete closure of Mindanao branch
200,000
Unpaid salary of the executive related to closure of
Mindanao branch (60% x 50,000)
30,000
Total provision for restructuring
1,730,000
The cost of P400,000 expected to be incurred in transferring the 50 employees to Manila
are not included in the restructuring provision because they relate to ongoing operations.
Only 60% of the January salary of the executive is included in the restructuring provision
because the remainder relates to the transfer of the 50 employees to Manila and general
administration.
2. Restructuring costs
1,730,000
Estimated liability for restructuring costs
1,730,000
74. Answer is P40,000,000
Lease termination penalty
Cost of hiring outplacement firm
Employee termination cost
Total restructuring provision
75. Requirement 1
2014
Jan 1
Oil tanker depot
6,000,000
Cash
1
Oil tanker depot
930,000
Decommissioning liability (1,500,000 x 0.62)
Dec. 31
Depreciation
1,386,000
Accum. depreciation (6,930,000/5)
31
Interest expense
93,000
Decommissioning liability (10% x 930,000)
Answer Explanation & Solutions
4,000,000
6,000,000
30,000,000
40,000,000
6,000,000
930,000
1,386,000
93,000
Page 79
FINANCIAL ACCOUNTING
Requirement 2
2018
Dec. 31
Accum. depreciation
6,930,000
Oil tanker depot
31
Decommissioning liability
1,500,000
Loss on settlement of decommissioning liability 200,000
Cash
76. Requirement 1
2014
Jan. 1
Mining site
8,000,000
Cash
1
Mining site
926,400
Decommissioning liability (2,000,000 x .4632)
Requirement 2
2023
Dec. 31
Decommissioning liability
2,000,000
Cash
Gain on settlement of decommissioning liability
77. Requirement 1 (2014)
Jan. 1
Detoxification facility
Cash
1
Dec. 31
31
Detoxification facility
Decommissioning liability (1,500,000 x .56)
6,930,000
1,700,000
8,000,000
926,400
1,800,000
200,000
9,000,000
9,000,000
840,000
840,000
Depreciation
984,000
Accumulated depreciation (9,840,000 / 10))
984000
Interest expense
Decommissioning liability (6% x 840,000)
50,400
50,400
Requirement 2 (2016)
Jan. 1
Detoxification facility
126,000
Decommissioning liability (200,000 x .63)
Dec. 31
Depreciation
999,750
Accumulated depreciation (9,840,000 / 10))
Answer Explanation & Solutions
126,000
999,750
Page 80
Provisions & Contingencies
Original cost
Additional cost
Total depreciation
31
(126,000 / 8)
Interest expense
Decommissioning liability (6% x 840,000)
Original liability
Interest for 2014
Carrying amount – 12/31/2014
Interest for 2015
Carrying amount – 12/31/2015
64,189
64,189
(6% x 840,000)
(6% x 890,400)
Interest for 2016
(6% x 943,824)
Interest for 2016 on additional liability 6% x 126,000)
Total interest for 2016
Requirement 3 (December 31, 2023)
Dec. 31
Accumulated depreciation
Detoxification facility
9,966,000
Purchase price
Original decommissioning cost
Additional decommissioning cost
Total cost
31
984,000
15,750
999,750
Decommissioning liability
1,700,000
Loss on settlement of decommissioning liability 300,000
Cash
840,000
50,400
890,400
53,424
943,824
56,629
7,560
64,189
9,966,000
9,000,000
840,000
126,000
9,966,000
2,000,000
78. 1. Only a disclosure is necessary because it is not probable that the company will be liable,
although the amount can be measured reliably.
2. Retained earnings
200,000
Estimated liability for income tax
200,000
3. Accounts receivable – Sunset
120,000
Loss on guaranty
80,000
Note payable – bank
200,000
Answer Explanation & Solutions
Page 81
FINANCIAL ACCOUNTING
79. The shipping company shall recognize a provision for P5,000,000 because the claim on the
international freight forwarding company is probable. No provision or disclosure would be
needed for the P2,000,000 claim of the international freight forwarding company because
there is a remote possibility for the payment. The shipping company shall also recognize a
contingent asset of P4,500,000 (90% x P5,000,000), because the amount is virtually certain
of collection.
80. 1. Unearned subscription revenue
Subscription revenue (3,000,000 – 2,300,000)
2. Loss on lawsuit
Estimated liability for lawsuit
3. Loss on lawsuit
Estimated liability for lawsuit
700,000
1,500,000
1,000,000
700,000
1,500,000
1,000,000
81. 1. Loss on lawsuit
800,000
Estimated liability for lawsuit (50% x 1,600,000)
800,000
2. Environmental cost
1,500,000
Estimated liability for environmental cost
1,500,000
3. No provision is recognized for the guaranty because there is only a remote likelihood
that future payment will be made.
82. 1. Long-term service leave – provision.
1,200,000
A provision is a present obligation that is uncertain in amount and timing. The present
obligation must be both probable and measurable.
2. The amount owing to another entity is a present obligation but technically it is not a
provision because the amount is certain. Of course, it is an accrued liability.
The estimated cost of relocating the employee is a future cost because it is to be incurred in
January 2015. Thus, it is not included in December 31, 2014 provision.
The estimated cost of overhaul is not a provision because there is no present obligation. The
company may decide to sell the machine or not to repair it.
83. Adjusting entries:
Doubtful accounts
Allowance for doubtful accounts
Loss on claim receivable
Claim receivable
Answer Explanation & Solutions
800,000
800,000
400,000
400,000
Page 82
Provisions & Contingencies
84. Adjusting entries:
1. The receivable of P400,000 is non-adjusting event because the amount is still collectible
although a longer term has been given but not so long as to cause it to be reclassified
as noncurrent.
2. Loss on lawsuit
Estimated liability for lawsuit
3,000,000
3. Doubtful accounts
3,150,000
Allowance for doubtful accounts (3,500,000 x 90%)
Answer Explanation & Solutions
3,000,000
3,150,000
Page 83