THE REVIEW SCHOOL OF ACCOUNTANCY (RESA)
QUIZZER 3 – LIABILITIES
PROBLEM 1: In the course of your audit of Probe Inc. for the year ended December 31, 2014,
you took note of the following information:
ITEM
a. Accounts payable – trade,
₱170,000
b. Notes payable – trade, ₱70,000
c. Advance receipts from customers
₱100,000
d. Containers Deposit, ₱50,000
e. Notes Payable – BPI, ₱200,000
f. Dividends in arrears on
cumulative preferred stock,
₱20,000
g. Stock dividends payable on
common stocks, ₱37,200
h. Liabilities under guarantee
agreement, ₱45,000
i. Convertible bonds, ₱1,000,000
j. Notes Payable – Officers,
₱40,000
k. Salaries and Wages
l. Notes Receivables, ₱30,000
m. Output VAT, ₱246,000
n. Accounts Receivable, ₱215,000
o. Cash in banks, ₱115,000
AUDIT NOTES
This amount is net of ₱30,000 accounts with
debit balances
The notes are all with five-month term bearing
interest at 15%. ₱50,000 from the notes is dated
September 1, while the rest are dated November
3.
The goods pertaining to these advances will be
delivered in 2015.
This is an amount received from customers for
returnable containers.
This is a long-term note for five years and are
being paid off at the rate of ₱4,000 per month
(monthly payment include interest).
The company is yet to declare dividends since its
last declared and distributed dividends in 2015.
This pertains to Probe’s guarantee of its
employees’ bank loans. As per past experience,
employees unlikely default on their loan
payments.
1,000 bonds is convertible to 10 ordinary shares.
Amount due on December 31, 2017.
This is due in six months.
Payroll for the period December 16, 2014 to
January 15, 2015 amounted to ₱68,000.
This note has been discounted in a bank on a
without-recourse basis, where the company
received cash of ₱24,000.
Input VAT on purchases and other operating
expenses amounted to ₱164,000.
The accounts receivable is net of ₱12,300
customer credit balances.
The company’s cash in banks include a cash
balance with BPI amounting to ₱125,000; with
PNB amounting to ₱55,000, and; an overdraft
balance with BDO.
Amount to date, ₱250,000
p. Common stock warrants
outstanding
q. Common stock-options
outstanding
r. Estimated warranty costs on
goods sold, ₱46,000
s. Instalment notes payable,
₱75,000
t. Provision for losses
Amount to date, ₱150,000
u. Deferred tax liability, ₱150,000
This pertains to warranty costs on goods sold in
2013 and 2014.
This is for the equipment purchases, only onethird is due in 2015.
During the year, one of the manufacturing
equipment of the company exploded injuring an
employee. The employee filed claims for damages
on November 3.there has still been no resolution
yet on the case as of the balance sheet date. The
company lawyers however believe that it is
probable that the company will be liable between
₱25,000 and ₱75,000.
This refers to deferred tax liabilities on
cumulative temporary difference on taxable
income and financial income which will reverse
evenly over the next year.
Requirements:
1.
a.
2.
a.
3.
a.
How much is the total current liabilities?
767,000
b. 814,300
c. 817,300
How much is the total noncurrent liabilities?
1,285,000
b. 1,360,000
c. 1,429,000
How much is the total liabilities?
2,177,300
b. 2,127,300
c. 2,246,300
d. 892,300
d. 1,760,000
d. 2,252,300
Solution and Explanation:
ITEM
CURRENT LIABILITIES
a
b
200,000*
70,000
3,000**
100,000
50,000
40,000***
-
c
d
e
f
g
NONCURRENT
LIABILITIES
160,000
-
h
i
j
40,000
k
34,000****
l
m
82,000*****
n
12,300
o
65,000
p
q
r
46,000
s
25,000******
t
50,000
u
TOTAL
(1) 817,300
*170,000+30,000
**(50,000x15%x4/12)+(20,000x15%x2/12)
***(200,000/5)
****68000x15/30
*****246,000-164,000
******75000x1/3
(3)
Current Liabilities
Noncurrent Liabilities
TOTAL LIABILITIES
1,000,000
50,000
150,000
(2) 1,360,000
817,300
1,360,000
2,177,300
Under IAS/PAS 1 paragraph 69, an entity shall classify a liability as current when:
(a) it expects to settle the liability in its normal operating cycle;
(b) it holds the liability primarily for the purpose of trading;
(c) the liability is due to be settled within twelve months after the reporting period; or
(d) It does not have an unconditional right to defer settlement of the liability for at
least twelve months after the reporting period (see paragraph 73). Terms of a
liability that could, at the option of the counterparty, result in its settlement by the
issue of equity instruments do not affect its classification.
An entity shall classify all other liabilities as non-current.
PROBLEM 2: You are auditing the 2014 liabilities of Bat Inc. which follows the calendar year
financial statements reporting. The following information were available with regards to its
currently maturing obligation:
a. On December 31, 2014, Bat Inc. had P1M of short-term notes payable due February 7,
2015. On January 15, 2015, the company issued bonds with a face value of P900,000 at
96; brokerage fees and other costs of issuance were P3,450. On January 22, 2015, the
proceeds from the bond issue plus additional cash held by the company on December 31,
2014 were used to liquidate the P1M of short-term notes.
b. Another short-term debt in the form of notes payable totaling to P500,000 were due on
June 1, 2015. On February 2, 2015, Batali entered an agreement with National Life
Insurance Co. where National will lend Batali P400,000 payable in 5 years at 14%, the
proceeds of which is intended to be used to partly refinance the said notes. The money
will be available to the company on May 20, 2015.
c. Another P500,000 notes payable is due on June 15, 2015. At the financial statement date
December 31, 2014, Batali signed an agreement to borrow up to P500,000 to refinance
the notes payable on a long-term basis. The financing agreement called for borrowings
not to exceed 80 per cent of the value of the collateral Batali was providing. At the date
of issue of the December 31, 2014 financial statements, the value of the collateral was
P600,000 and was not expected to fall below this amount during 2015.
Assuming that the financial statements of Batali were authorized to be issued on March 31, 2015:
4.
How much liabilities above are short-term as of the balance sheet date?
a. 1,500,000
5.
b. 1,520,000
c. 1,980,000
d. 2,000,000
How much liabilities above are long-term as of the balance sheet date?
a. 2,000,000
b. 1,500,000
c. 980,000
d. 480,000
Solution and explanation:
a P1,000,000 short-term notes payable
due on February 7, 2015
b P500,000 short-term notes payable due
on June 1, 2015
c P500,000 notes payable due on June
15, 2015 refinanced (600,000 x 80%)
CURRENT
P1,000,000
NONCURRENT
500,000
20,000
480,000
P1,520,000
P480,000
PAS 1, paragraph 69, provides that an entity shall classify a liability as current when it is
expected to be settled in its normal operating cycle;held primarily for the purpose of trading;due
to be settled within twelve months after the reporting period, even if the original term was for a
period longer than twelve months, and agreement to refinance, or to reschedule payments, on a
long-term basis is completed after the reporting period and before the financial statements are
authorized for issue; the entity does not have an unconditional right to defer settlement of the
liability for at least twelve months after the reporting period
However, if the refinancing on a long-term basis is completed on or before the end of the
reporting period, the refinancing is an adjusting event and therefore the obligation is classified as
noncurrent.
An entity shall classify all other liabilities as non-current.
PROBLEM 3: Rado Inc. a manufacturer of heavy machinery, grants 2-year warranty on its
products. The estimated Liability for product warranty account shows the following entries for
the year:
Beginning balance
Provisions during the year (quarterly accrual)
Total
P225,000
200,000
P425,000
A review of the company’s policy of accounting for warranties revealed that based on the
company’s past experience, warrant claims averaged 5% on net sales, Moreover the company
provides for a quarterly accrual of the estimated warranties expenditure based on rough
estimates.
The following additional information is available from the company’s records:
Gross Sales
Sales returns and Allowances
Cost of sales
P7,250,000
150,000
6,378,000
The cost of sales included P415,000 cost of servicing warranty claims for the year.
6. What is the correct balance of the estimated liability for product warranty at the end of the
year?
a. 164,500
c. 355,000
b. 264,500
d. 364,500
Solution and Explanation:
According to PAS 37-Provisions, Contingent Liabilities and Contingent Assets
On the valuation of contingent liabilities:
“The amount recognized as a provision shall be the best estimate of the expenditure required to
settle the present obligation at the end of the reporting period. 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 the reporting period or to transfer it to a third party at
that time.”
This means that companies must provide a provision for their contingent liabilities. The value of
this provision is the best estimate of the company throughout it’s experience and practice. In this
problem, the information given was company’s policy of accounting for warranties, warrant
claims averaged 5% on net sales. This means that the provision is 5% of net sales.
To compute for Provision on warranties:
Gross Sales
Less: Sales returns and Allowances
Net Sales
Percentage for provision
Provision for the year
P7,250,000
(150,000)
7,100,000
x5%
355,000
This is recorded by debiting Warranty Expense and Crediting Estimated Warranty Liability.
In order to get the accumulated balance of Estimated Warranty Liability we simply add prior
period warranty liabilities
Beginning Balance of warranty Liability
Provision for warranty Liability
Warranty Liabilities paid during the year
225,000
355,000
(415,500)
Php 164,500 A.
Problem 4: SAN MIG CORP. began operation on January 2, 2014 with 250 employees. The
company provides its employees 2 weeks paid sick leave and 2 weeks paid vacation leave for
every operating year. The company’s police on sick leave and vacation leave allows each
employee to carry over accumulated leaves current period over the next year only. The same
shall be forfeited if not availed over the said period allowed.
On December 31, 2014, records show that there are 55 employees who are yet to avail of any
leaves while there are 25 employees who have remaining 2 weeks unused vacation and sick
leaves combined. Employees had an average daily wage rate if P250 for a 5-day weakly
operation in 2014.
On December 31, 2015, records show that 925 days of vacation and sick leave carried over from
the last operation period were exercised and paid in 2015. In addition, there are 30 employees
who have 6 weeks left accumulated unused sick leaves and vacation leaves combined; 25
employees who have accumulated 3 weeks unused sick leaves and 2 weeks unused vacation
leaves; 30 employees who have accumulated 3 weeks unused sick leaves and vacation leaves
combined; 10 employees who have accumulated 1 week unused sick leaves and 1 week unused
vacation leaves. Employees had an average daily wage rate of P275 for a 50day weekly
operation.
7. How much liability for compensated absences should be included as current liabilities as
of December 31, 2014?
a. 570,625
b. 453,750
c. 412,500
d. 337,500
8. How much liability for compensated absences should be included as current liabilities as
of December 31, 2015?
a. 570,625
b. 453,750
c. 412,500
d. 337,500
Solution and Explanation:
7.
55 employees x 20 days
25 employees x 10 days
Total days of compensated absences
x
Daily rate
Total Current Liability for Compensated Absences, 2014
1100
250
1350
P
250
P 337,500
8.
30 employees x 20 days
25 employees x 20 days
30 employees x 15 days
10 employees x 10 days
Total days of compensated absences
x
Daily rate
Total Current Liability for Compensated Absences, 2015
600
500
450
100
1350
P
275
P 453,750
Under PAS 19 Employee Benefits, compensated absences falls under the short term employee
benefits.
“Short-term employee benefits include items such as:
(a) wages, salaries and social security contributions;
(b) short-term compensated absences (such as paid annual leave and paid sick leave) where the
compensation for the absences is due to be settled within 12 months after the end of the period in
which the employees render the related employee service;
(c) profit-sharing and bonuses payable within twelve months after the end of the period in which
the employees render the related service; and
(d) non-monetary benefits (such as medical care, housing, cars and free or subsidized goods or
services) for current employees.”
“Liability is also recognized as to the portion not yet paid by the company, PAS 19 par. 10 makes
it clear.
When an employee has rendered service to an entity during an accounting period, the entity
shall recognised the undiscounted amount of short-term employee benefits expected to be paid in
exchange for that service:
(a) as a liability (accrued expense), after deducting any amount already paid. If the amount
already paid exceeds the undiscounted amount of the benefits, an entity shall recognise that
excess as an asset (prepaid expense) to the extent that the prepayment will lead to, for example,
a reduction in future payments or a cash refund; and
(b) as an expense, unless another Standard requires or permits the inclusion of the benefits in the
cost of an asset”
Par. 11 to 13 also indicates that compensated absences can be accumulating or non-accumulating
and the reasons for the absences:
“An entity shall recognize the expected cost of short-term employee benefits in the form of
compensated absences under paragraph 10 as follows:
(a) in the case of accumulating compensated absences, when the employees render service that
increases their entitlement to future compensated absences; and
(b) in the case of non-accumulating compensated absences, when the absences occur.
An entity may compensate employees for absence for various reasons including vacation,
sickness and short-term disability, maternity or paternity, jury service and military service.
Entitlement to compensated absences falls into two categories:
(a) accumulating; and
(b) non-accumulating.
Accumulating compensated absences are those that are carried forward and can be used in
future periods if the current period’s entitlement is not used in full.”
PROBLEM 5: CUMMINGS INC. manufactures and sells air conditioning units with a 12
months warranty under which defective air conditioning units will be replaced free of any
charges.
The company started out in 2014 expecting 10% of the sales to be returned. However, due to the
innovations and improvements made to the products during the year, the estimated percentage if
returns increased to 15% on July 1. It is assumed that no units sold during a given quarter are
returned in that quarter. Each unit is stamped with a date at time of sale so that the warranty may
be properly administered. The following table of percentages indicates the pattern of sales return
during the 12-month period of warranty, starting with the quarter following the sale of air
conditioning units.
QUARTER FOLLOWING QUARTER OF SALE
First Quarter
% OF TOTAL RETURNS EXPECTED
40%
Second Quarter
Third Quarter
Fourth Quarter
30%
20%
10%
Gross sales of air conditioning units in 2014 are as follows:
QUARTER
First
Second
Third
Fourth
SALES IN PESO
Php 16,200,000
14,850,000
12,000,000
8,100,000
The company also pays for the freight costs of the return and the delivery of the defective units
returned and the new replacement units, respectively. The freight cost were approximately 10%
of the sales price of the air conditioning units returned. The manufacturing cost of the air
conditioning units are roughly 80% of the sales price. The returned units can be salvaged at an
estimated value of 15% of their sales price. The returned units on hand at December 31,2014,
were thus valued in the inventory at 15% of their original sales price.
Requirements:
9. What is the total estimated returns for the year ended December 31, 2014?
a. 5,115,000
b. 6,120,00
c. 6,300,000
d. 7,672,500
Solution:
Q1
16,200,000
10%
Q2
14,850,000
10%
Q3
12,000,000
15%
Q4
8,100,000
15%
TOTAL ESTIMATED RETURNS
Php 1,620,000
1,485,000
1,800,000
1,215,000
Php 6,120,000
10. What is the warranty expense for the year ended December 31, 2014?
a. 4,590,000
b. 4,896,000
c. 5,508,000
d. 6,120,000
Solution:
Manufacturing cost
( 6,120,000 x 80% )
Freight cost
( 6,120,000 x 10% )
Salvage Value
( 6,120,000 x 15% )
Php 4,896,000
612,000
918,000
WARRANTY EXPENSE
Php 4,590,000
11. What is the estimated warranties payable as of December 31, 2014?
a. 2,176,875
b. 2,205,900
c. 2,322,000
d. 2,612,250
Solution:
Q1
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q2
40%
Q3
30%
40%
Estimated Returns
1,620,000
1,485,000
1,800,000
1,215,000
Manufacturing cost
( 2,902,500 x 80% )
Freight cost
( 2,902,500 x 10% )
Salvage Value
( 2,902,500 x 15% )
Estimated warranties payable
Q4
20%
30%
40%
10%
30%
60%
100%
Expected % of returns
10%
30%
60%
100%
Php 162,000
445,500
1,080,000
1,215,000
Php 2,902,500
Php 2,322,000
290,250
435,300
Php 2,176,875
Explanation:
Under PAS 37, paragraph 24, Where there are a number of similar obligations (eg
product warranties or similar contracts) the probability that an outflow will be required
in settlement is determined by considering the class of obligations as a whole. Although
the likelihood of outflow for any one item may be small, it may well be probable that
some outflow of resources will be needed to settle the class of obligations as a whole. If
that is the case, a provision is recognised (if the other recognition criteria are met).
PROBLEM 6: Mountain Province Home Depot carries a wide variety of promotion techniques
to attract customers.
Kitchen and home appliances are sold in a one-year warranty for replacement of parts and labor.
The estimated warranty cost, based on past experience, is 5% of sales.
The premium offered on the home furniture. Customer receive a coupon for each peso spent on
home furniture. Customers may exchange 2,000 coupons and P50 for a rice cooker which the
company purchased at P340 for each rice cooker and estimates that 60% of the coupons given to
the customers will be redeemed.
The company’s total sales for 2014 were P115.2M – P86.4M from kitchen and home appliances
and P28.7M from home furniture. Replacement parts and labor for warranty work totaled
P2.624M during 2014. A total of 5,200 rice cookers used in the premium program were
purchased during the year and there were 9,600,00 coupons redeemed in 2014
The accrual method is used by the company to account for the warranty and premium costs for
financial reporting purposes. The balance in the accounts related to warranties and premiums on
January 1, 2014, were shown below:
Inventory of Premium Items
Estimated liabilities for premiums
Estimated liabilities for warranties
P340,000
716,000
2,176,000
Based on the information above, determine:
1. Promotional expense related to the premiums for the current year 2014?
a. 1,392,000
b. 1,632,000
c.
d.
2,505,600
2,937,600
Solution and Explanation:
Revenue from Home Furniture
Rate of coupons estimated to be redeemed
Coupons estimated to be redeemed
Coupons needed to be used in order to claim premium
Estimated premium to be claimed
Price Paid for the premium item (P340-50)
Promotional Expense
₱28,800,000.0
0
0.60
17,280,000.00
2,000.00
8,640.00
₱
290.00
₱2,505,600.0
0
The estimated premiums to be claimed shall be expensed and shall be considered as a
liability. It shall be reduced by the actual distribution of the premium to the customer.
2. Estimated liabilities for premiums as of December 31, 2014?
a. 716,000
b. 1,829,000
c.
d.
2,021,600
1,589,600
Solution and Explanation:
₱716,000
2,505,600
(1,392,000)
₱ 1,892,600
Estimated Liabilities for Premiums 1/1/14
Add: Promotional Expense
Less: Actual Promotional Expense (4,800*290)
Estimated Liabilities for Premiums 12/31/14
According to Valix, premiums are used to stimulate sales. When the merchandise is sold,
an accounting liability for the future distribution of premium arises and should be given
accounting recognition. It should be noted that actual premiums claimed shall be deducted to the
liability.
3. Estimated liabilities for warranties as of December 31, 2014?
a. 2,624,000
b. 3,872,000
c.
d.
4,320,000
5,312,000
Solution and Explanation:
Revenue from Kitchen and Home Appliance
Rate of estimated warranty cost
Estimated Warranty Cost
Actual Replacement and Rework Cost
Estimated Liabilities for Warranties, 1/1/14
Estimated Liabilities for Warranties, 12/31/14
₱ 86,400,000
5%
4,320,000
(2,624,000)
2,176,000
₱ 3,872,000
As Valix have said in his book, home appliances are sold under warranty to provide free
repair services or replacement. Liability is incurred at the point of sale for warranty. It is
deducted by the actual warranties expense incurred.
PROBLEM 7: OCAMPO APPLIANCE CENTER reports the following liability items in its
balance sheet as of December 31, 2014.
Liability for unredeemed coupons
Unearned service contracts
Accrued officer bonuses
P109,750
300,000
----0-----
a. The liability for unredeemed coupons are in relation to discount coupons distributed by
the company to customers who may present the same discounts as indicated in the face of
the coupons. Distributors are reimbursed for the face value of coupons redeemed, plus
10% of the coupon value for handling costs. The company honors requests for coupon
reimbursements to distributors three months after the expiration date. In OCAMPO’S
experience 75% of the coupons issued ultimately are redeemed by the customers. Total
face value coupons issued during the year and expiring on December 31, 2014 amounted
to P250,000 while total payments to distributors as of the same date is at P140,250. The
total coupon value was set up as a liability while the total payments were charged against
the liability set up.
b. Aside from the company’s normal selling operations, it also sells equipment service
contracts agreeing to service equipment for a two-year period. Revenue from the service
contracts is recognized as earned over the lives of contracts. Additional information
shows that Unearned service contract revenue at January 1, 2014 is at P300,000; Cash
receipts from the service contracts sold is at P490,000 recorded as revenue; Service
contract revenue actually realized is at P430,000
c. The company provides a special bonus for its executive officers based on 10% of it’s net
income before bonus but after income taxt. Net income for the year vefore tax and before
adjustments related to previous information is at P1,016,250. (Assume income tax rate is
35%). Accrual is yet to be made on the bonuses.
15. What is the adjusted balance of the liability for unredeemed coupons?
a. 134,750
b. 109,750
c. 66,000
d. 47,250
Solution and Explanation:
According to PAS 37-Provisions, Contingent Liabilities and Contingent Assets
On the valuation of contingent liabilities:
“The amount recognized as a provision shall be the best estimate of the expenditure
required to settle the present obligation at the end of the reporting period. 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 the reporting period or to
transfer it to a third party at that time.”
This means that not all of the contingent liability provided should be considered to be an
obligation. On the above given the whole amount of 250,000 was set up as liability. This
should not be the case since PAS 37 clearly states that a provision shall be made for the
best estimate of an expenditure. From the experience of the company normally 75% of
the coupons are redeemed. The provision is computed as follows
FV of Coupon
250,000
Handling costs(this is also a liability) 25,000 (250,000x10%)
Total
275,000
Percentage estimate of redemptions
75%
Provisions for Coupon liability
206,250
Paid Coupon Liabilities
(139,200)
Unredeemed Coupon liabilities
66,000 C.
16. What is the adjusted balance of the unearned service contracts?
a. 240,000
b. 300,000
c. 360,000
d. 490,000
Solution and Explanation:
It is stated in the above information that Revenue from service contracts is recognized as
earned over the life of the contracts. This means that when cash is received a portion of it
must be recognized as unearned revenue and should not be recorded as outright revenue.
To acquire the year end unearned revenue, it is simply done by adding prior period
unearned revenue and unearned revenue received in the current year (through receiving
post payments) and deducting the actual realized revenue. Unearned revenue is a liability
account to be settled by providing services.
Unearned Revenue Beg Jan 1, 2014
Unearned revenue for the year from cash receipts
Less: Actual revenue realized through the contract period
Unearned Revenue End Dec 31, 2014
300,000
490,000
(430,000)
360,000 C.
17. What is the adjusted balance of the accrued officer bonuses accounts?
a. 61,032
b. 67,358
c. 90,909
d. 100,000
Solution and Explanation:
According to valix bonuses are a percentage of Net income and they can either be Before
Bonus and Tax, Before Bonus and After Tax, After Bonus and After Tax or After Bonus
and Before Tax.
In computing for this, it requires basic algebraic analysis. But first there is a need to
adjust the Net income from the above corrections
Unadjusted Net Income
1,016,250
Overstatement of expense recognized on
liability of unredeemed coupons(109,750 – 66,000)
Overstatement of revenue recognized on
service contracts (300,000 – 360,000)
Adjusted Net income
43,750
(60,000)
1,000,000
To compute for bonus, before bonus but after tax income
B-Bonus (Bonus is 10% of Income before bonus but after tax)
T-Tax (T= Tax percentage( NI – B)) Tax percentage is 35%
NI- Net income
B = 10%(NI – T)
B = 10%(1,000,000 – T)
B = 10%(1,000,000 – (35%(1,000,000 – B))
B= 10%(1,000,000 –(350,000 - .35B)
B= 10% (1,000,000 – 350,000 + .35B)
B = 10%(650,000 + .35B)
B= 65,000 + .035B
B - .035B = 65,000
.965B = 65,000
.965B/.965 = 65,000/.965
B= 67,358 B.
PROBLEM 10: You were assigned to audit the financial statements of PIPINO CORP. for the
year ended December 31, 2014. The liability portion of the company’s balance sheet shows the
following information:
Noncurrent Liabilities
Notes payable
Liability under capital lease
Current Liabilities
Accounts Payable
Warranties Liability
Deferred tax Liability
Total
P7,195,000
2,240,000
1,840,000
42,500
250,000
9,435,000
2,048,000
P11,483,000
Upon further investigation on liabilities account, you discovered the following information:
a.
The principal amount of the note payable is P8,000,000 and bears interest at
12% payable every March 31. The note is dated April 1, 2012 and is due 5
years after issuance, The prevailing market rate of interest when the notes
were issued was at 15%. The entry made by the client on April 1, 2012 was
debit to cash and credit to notes payable for the cash consideration received.
No other entry has been made since apart from the annual interest payments
every March 31, being debited to interest expense and credited to cash.
b.
c.
The capitalized lease is for an eight-year period beginning December 31,
2011. Equal annual payments of P1,200,000 are due of December 31 of each
year beginning December 31, 2011. The implicit rate of the lease known to
PIPINO is 10%. The asset was record by the company as a debit to the
liability under capital lease account.
The result of purchase cutoff on the company’s purchases transactions from
December 15 to January 15 you have rendered is shown below:
Receiving Invoice Date Receiving Shipment Terms
Report no.
Report Date
65212
65213
65214
65215
65216
65217
65218
65219
65220
65221
65222
12/15/2014
12/17/2014
12/21/2014
12/26/2014
12/30/2014
12/30/2014
12/31/2014
01/02/2014
01/05/2014
01/07/2014
01/10/2014
12/15/2014
12/20/2014
12/21/2014
12/30/2014
01/02/2014
01/02/2014
01/03/2014
01/05/2014
01/10/2014
01/11/2014
01/15/2014
Amount
FOB Shipping Point
FOB Shipping Point
FOB Destination
FOB Destination
FOB Shipping Point
FOB Shipping Point
FOB Destination
FOB Buyer
FOB Shipping Point
FOB Shipping Point
FOB Destination
15,000
16,000
17,500
20,000
30,000
28,000
19,000
30,500
41,000
22,000
25,000
Investigations revealed that the last receiving report recorded in the voucher register was
RR65220
d.
The company has a two-year warranty on its products. The warrant estimates
in the past years were at 5% of the net sales. During the current year because
of increased returns the company decided to increase warranty estimates at
8% of its total net sales, 7% of which is expected to be incurred during the
year of sale and the balance on the year following the year of sale. Presented
below are information relevant to your audit:
2012
2013
2014
Net Sales
P24,000,000
27,150,000
31,650,000
Actual Warranty
1,150,000
1,450,000
1,950,000
costs paid
The company is yet to update its warranty liabilities as of December 31, 2014.
Required:
29. What is the correct balance of the Notes Payable as of December 31, 2014?
a. 7,314,250
b. 7,451,388
c. 7,568,669
d. 7,609,096
Solution and Explanation:
According to Valix Effective interest Method is used for computing the balance of
notes payable.
Effective interest method involves using the PV of 1 multiplied to the face amount
and PV of ordinary annuity multiplied to interest per year or cash payment per year.
PV of 1 using 15% FMV rate for 5 years is = .4972
PV of ordinary annuity using 15% FMV rate for 5 years is = 3.3522
In order to get the initial carrying value of the Note Computation is as follows
8,000,000 x .4972 =
3,977,413
8,000,000 x 12% =
960,000
960,000 x 3.3522
3,218,068
Initial Carrying Value
7,195,438
To compute the Carrying value at December 31, 2014. An amortization table is
constructed.
Date
4/1/12
3/31/13
3/31/14
*12/31/14
Payment
Interest Expense
960,000
960,000
*720,000
1,079,322
119,322
1,097,214
137,214
*838,347
118,347
Disparity due to round-off
*Accrued for April to Dec
April – Dec = 9 months
Payment = 960,000x9/12 = 720,000
Discount
Carrying amount
7,195,438
7,314,760
7,451,974
7,570,321
(652)
7,569,669 C.
Interest Expense = 1,117,796x9/12 = 838,347
30. What is the initial amount debited to the asset account at the inception of the finance
lease?
a. 2,240,000
b. 3,440,000
c. 5,640,000
d. 7,040,000
Solution and Explanation:
In the information provided, recorded on the books were an outstanding Capital Lease
Liability of 2,240,000, this was obtained by decreasing the initial amount debited to the
liability by lease payments per year.
To calculate lease payments:
12/31/11
1,200,000
12/31/12
1,200,000
12/31/13
1,200,000
12/31/14
1,200,000
Total Lease Payments 4,800,000
To compute initial amount debited
Squeeze or Workback
Initial Amount Debited7,040,000 D.
Payments
4,800,000
Remaining
2,240,000
Lease Liability
32. What is the correct Accounts Payable as of December 31, 2014?
a. 1,722,000
b. 1,750,000
c. 1,778,000
d. 1,797,000
Solution and Explanation:
According to Valix purchases and sales should be recognized once the goods in transit are
received when the Shipment Term is FOB Destination; and when the term is FOB Shipping
Point the purchases and sales should be recognized when the goods are in transit. Applying
this, it can be analyzed that certain Purchases in the above information should still not be
recorded as Accounts payable.
In order to compute for the adjusted accounts payable
Unadjusted accounts payable
1,840,000
RR65218 Terms FOB Destination, the goods were received 2015
(19,000)
RR65219 This was recorded in 2014, when it should properly be recorded 2015 (30,500)
RR65220 This was recorded in 2014, when it should properly be recorded 2015 (41,000)
Adjusted accounts payable
1,750,000 B.
33. What is the correct warranties expense in 2014?
a. 582,000
b. 1,582,500
c. 1,950,000
d. 2,532,000
Solution and Explanation:
According to PAS 37-Provisions, Contingent Liabilities and Contingent Assets
On the valuation of contingent liabilities:
“The amount recognized as a provision shall be the best estimate of the expenditure
required to settle the present obligation at the end of the reporting period. 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 the reporting
period or to transfer it to a third party at that time.”
Analyzing the information given the percentage estimate designated for warranty
expense provision for the current year is 8% of net sales
To compute for warranties expense for the current year:
Net Sales
31,650,000
Warrant estimate percentage
8%
Warranty Expense recognized
2,532,000 D.
in 2014
PROBLEM 11. ADELAIDA INC. had the following unadjusted liability balances as of
December 31, 2014:
Account Payable
Premiums Payable
Deferred Taxes
10% Bonds Payable
P 540,000
140,000
( 42,000 )
5,500,000
Audit Notes:
a.
b.
Accounts payable is net of a Php 50,000 debit balance in one of the company’s suppliers
accounts due to an overpayment made. The agreement with the supplier simply calls for the
supplier to deliver additional merchandise to Adelaida Inc. to offset the overpayment. No
deliveries were made as of the balance sheet date.
The company started a promotional program in 2013 where an eco-friendly tote bag shall
be given to customers upon presenting 6 product labels plus P5 cash. The following
information are deemed relevant in relation to the program:
Sales
Total cost of tote bags purchased (P25 each)
Tote bags actually distributed
Estimated tote bags to be distributed the
following year
2013
P 7,200,000
375,000
9,000
7,000
2014
P 8,400,000
500,000
19,000
5,000
The balance of the premiums liability account, reflects the accrual at the end of the
previous year (2013), no entry had been made during the current year affecting the said
account.
c.
Deferred tax balance appearing above is the result of the deferred tax created by the
premiums liability in the previous year which is tax deductible upon settlement.
Adjustments are yet to be made to the said account to reflect the movement in the account
balance during the year. Moreover, another temporary difference arising during the year
created by the company’s excess tax depreciation over financial depreciation for the period
amounted to P 150,000. The income tax rate is at 30%.
d.
The balance of the bonds payable account was the total proceeds from its issuance on
January 1,2014. The bonds which shall mature on December 31, 2018 have a total face
value of P 5,000,000 and are convertible into ordinary shares at the rate of P 1,000 bond to
10, P50 par value ordinary shares. On the issuance date the effective yield rate on similar
securities without the convertibility option was at 8% while each ordinary shares were
selling P75 per share. The only other entry made by the client in the relation to the bonds
was the payment of interest on December 31, as interest are payable annually every
December 31.
Required:
35. What is the correct premium expense for 2014?
a. 320,000
b. 480,000
c. 380,000
d. 340,000
Solution:
Premium distributed in 2014
Premium to be distributed the
following year
Total
Premium arising from 2013 sales
distributed in 2014
Premium applicable in 2014
Php 19,000
5,000
Php 24,000
(7,000)
Php 17,000
Premium Expense
( 17,000 x 20 )
Php 340,000
Explanation:
When the merchandise is sold, an accounting liability for the future distribution of the
premium arises and should be given accounting recognition. (Financial Accounting 2,
page 39)
36. What is the total deferred tax liability as of December 31, 2014?
a. 30,000
b. 15,000
c. 45,000
Solution:
150,000 x 30% = Php 45,000
Explanation:
d. 75,000
Under PAS12, paragraph 46, Current and deferred tax assets and liabilities are usually
measured using the tax rates (and tax laws) that have been enacted. However, in some
jurisdictions, announcements of tax rates (and tax laws) by the government have the
substantive effect of actual enactment, which may follow the announcement by a
period of several months. In these circumstances, tax assets and liabilities are measured
using the announced tax rate (and tax laws).
37. What is the total current liability to be reported in the 2014 statement of financial position?
a. 735,000
b. 590,000
c. 890,000
d. 690,000
Solution:
Account Payable
Account Payable – debit balance
Premium 2014 to be distributed
the following year
( 5,000 x 20 )
Total current liability
Php 540,000
50,000
100,000
Php 690,000
Explanation:
Under PAS1, paragraph 69,An entity shall classify a liability as current when:
(a) it expects to settle the liability in its normal operating cycle;
(b) it holds the liability primarily for the purpose of trading;
(c) the liability is due to be settled within twelve months after the reporting period; or
(d) it does not have an unconditional right to defer settlement of the liability for at least twelve
months after the reporting period (see paragraph 73). Terms of a liability that could, at the option
of the counterparty, result in its settlement by the issue of equity instruments do not affect its
classification.
An entity shall classify all other liabilities as non-current.
Paragraph 72 states that, An entity classifies its financial liabilities as current when they are due
to be settled within twelve months after the reporting period, even if:
(a) the original term was for a period longer than twelve months, and
(b) an agreement to refinance, or to reschedule payments, on a long-term basis is completed after
the reporting period and before the financial statements are authorised for issue.
Paragraph 74, When an entity breaches a provision of a long-term loan arrangement on or before
the end of the reporting period with the effect that the liability becomes payable on demand, it
classifies the liability as current, even if the lender agreed, after the reporting period and before
the authorisation of the financial statements for issue, not to demand payment as a consequence
of the breach. An entity classifies the liability as current because, at the end of the reporting
period, it does not have an unconditional right to defer its settlement for at least twelve months
after that date.
Moreover, paragraph 71 states that an entity classifies the liability as non-current if the lender
agreed by the end of the reporting period to provide a period of grace ending at least twelve
months after the reporting period, within which the entity can rectify the breach and during
which the lender cannot demand immediate repayment.
38. What is the correct credit to shareholders’ equity account as a result of the issuance of the
bonds on January 2014?
a. 100,729
b. 399,271
c. 168,787
d. 500,000
Solution:
PV Factor of 1
0.68058 x 5,000,000
(1+8%)^-5
PV ordinary
3.99271 x 5,000,000 x 10%
annuity
1-(1+8%)^-5/8%
CARRYING AMOUNT, BEG
Total proceed
PV balance
Equity component
Php 3,402,900
1,996,355
Php 5,399,255
Php 5,500,000
5,399,255
Php 100,745
Explanation:
IFRS 9 deals with the measurement of financial assets and financial liabilities. Equity
instruments are instruments that evidence a residual interest in the assets of an entity after
deducting all of its liabilities. Therefore, when the initial carrying amount of a compound
financial instrument is allocated to its equity and liability components, the equity component is
assigned the residual amount after deducting from the fair value of the instrument as a whole the
amount separately determined for the liability component.
39. Assuming that the bonds were converted on January 2,2016, what is the total credit to share
premium as a result of the conversion?
a. 2,761,439
b. 2,831,213
c. 2,931,213
d. 2,858,439
Solution:
Jan 2014
Dec 2014
Dec 2015
Interest Paid
Interest
Expense
Amortizatio
n
500,000
500,000
431,940
426,496
68,060
73,504
Jan 2016 Carrying Amount
Share premium conversion
Total
Ordinary share
(5,000 x 10 x 50)
Share premium issuance
Carrying
amount
Php 5,399,255
5,331,195
5,257,691
Php 5,257,691
100,745
Php 5,358,436
(2,500,000)
Php 2,858,436
Explanation:
According to PAS 32,paragraph AG31, A common form of compound financial instrument is a
debt instrument with an embedded conversion option, such as a bond convertible into ordinary
shares of the issuer, and without any other embedded derivative features. Paragraph 28 requires
the issuer of such a financial instrument to present the liability component and the equity
component separately in the statement of financial position, as follows
(a) The issuer’s obligation to make scheduled payments of interest and principal is a financial
liability that exists as long as the instrument is not converted. On initial recognition, the fair
value of the liability component is the present value of the contractually determined stream of
future cash flows discounted at the rate of interest applied at that time by the market to
instruments of comparable credit status and providing substantially the same cash flows, on the
same terms, but without the conversion option.
(b) The equity instrument is an embedded option to convert the liability into equity of the issuer.
This option has value on initial recognition even when it is out of the money.
40. Assuming that the bonds were retired on January 2,2016 at 105, when the prevailing market
rate of interest for similar securities without conversion option is at 12%, how much should be
reported in the profit or loss as a result of the retirement?
a. 571,396
Solution:
b. 497,893
c. 639,454
PV Factor of 1
0.57 x 5,000,000
(1+12%)^-5
PV ordinary annuity 3.60478 x 5,000,000 x 10%
1-(1+12%)^-5/12%
CARRYING AMOUNT, BEG
Jan 2014
Dec 2014
Dec 2015
Php 2,850,000
1,802,390
Php 4,652,390
Interest Paid
Interest
Expense
Amortizatio
n
500,000
500,000
558,287
565,281
58,287
65,281
Jan 2016 Carrying Amount
Retirement of bonds
(5,000,000 x 105%)
Loss on retirement
Carrying
amount
Php 4,652,390
4,710,677
4,775,958
Php 4,775,958
5,250,00
Php 474,042
Explanation:
When an entity extinguishes a convertible instrument before maturity through an early
redemption or repurchase in which the original conversion privileges are unchanged, the entity
allocates the consideration paid and any transaction costs for the repurchase or redemption to the
liability and equity components of the instrument at the date of the transaction. The method used
in allocating the consideration paid and transaction costs to the separate components is consistent
with that used in the original allocation to the separate components of the proceeds received by
the entity when the convertible instrument was issued, in accordance with paragraphs 28–32.
PROBLEM 12: You are auditing the financial statements of Labandera Inc, a company which
carries a wide variety of laundry appliance and supplies, for the year ended December 31, 2014.
Information about the company’s varied liability accounts are as follows:
a. Premiums items are being offered to its Class A (residential use) washing machines and
dryers. Customers shall receive a coupon for each P50 spent on Class A laundry
appliance. Customers may exchange 400 coupons and P1,000 for a dryer. Labandera pays
P5,100 for each dryer and estimates that 60% of the coupons given to the customers will
be redeemed. A total of 4,500 dryers to be used on the premium program were purchased
during the year and there were 1,680,000 coupons redeemed during the year
b. Class B laundry appliances are sold with two-year warranty for replacement of parts and
labor. The estimated warranty cost, based on the past experience, is 1% of sales to be
incurred on the year of sale and 2% of sales to be incurred on the year following the year
of sale. Replacement parts and labor for warranty work totaled P1,640,000 during 2014
c. The company provides key employees 5% bonus based on the net income of the company
after tax. The same is yet to be accrued at year end.
d. Labandera uses the accrual method to account for the warranty and premium costs for
financial reporting purposes. Labandera’s sales for 2014 totaled P280,000,000, 60% of
which is attributed to Class A laundry appliance sales.
e. The company reported the following:
Inventory of Premium Items
Premium Expense
Warranties Expense
Net Income, before 35% income tax and before any
adjustments
₱ 1,530,000
17,220,000
1,640,000
80,164,000
41. What is the correct premiums liability as of December 31, 2014?
a.
4,284,000
b. 3,444,000
c. 1,530,000
d.
1,230,000
Solution and Explanation:
Sales for Class A Appliance (280M x 60%)
Number of Coupons given (168M/50)
Estimated Coupons to be redeemed (3.36M x 60%)
Cost of the premium (5,100 – 1,000)
Total Premium Liability [(2.016M/400) x 4100]
Less: Redeemed Premiums [(1.68M/400) x 4100)
Premiums Liability as of 12/31/14
₱168,000,000
₱3,360,000
₱2,016,000
₱ 4,100
20,664,000
17,220,000
₱3,444,000
According to Valix, premiums are used to stimulate sales. When the merchandise is sold,
an accounting liability for the future distribution of premium arises and should be given
accounting recognition.
42. What is the correct warranties expense?
a.
1,640,000
b.
1,720,000
c. 2,240,000
d. 3,360,000
Solution and Explanation:
Sales for Class B Appliance (205M x 40%)
Estimated Warranty Cost Rate
Correct Warranty Expense
₱112,000,000
3%
₱3,360,000
As Valix have said in his book, home appliances are sold under warranty to provide free
repair services or replacement. Liability is incurred at the point of sale for warranty.
43. What is the total bonus to key employees?
a.
2,395,577
b.
2,468,354
c. 2,480,916
d.
3,865,504
c. 25,411,548
d.
25,897,074
c. 47,192,875
d.
46,237,422
44. What is the correct income tax?
a.
25,381,679
b.
25,386,076
45. What is the correct net income?
a.
47,137,405
b.
47,145,570
Solution and Explanation:
Unadjusted Net Income
Less: Unrecorded Premium Expense (20.664M – 17.220M)
Less: Unrecorded Warranties Expense
Adjusted Net Income before tax and before bonuses
Let B = Bonuses
T = Tax
B = 5% (75,000,000 – T)
T = 35% (75,000,000 – B)
B = 0.05 {75,000,000 – {0.35(75,000,000 - B)]}
B = 0.05 (75,000,000 – 26,250,000 + 0.35B)
B = 2,437,500 + 0.0175B
0.9825B = 2,437,500
B = 2,480,91
6
80,164,000
(3,444,000)
(1,720,000)
75,000,000
Adjusted Net Income
Less: Bonuses
Net Income after Bonuses
Less: Taxes (72,519,084 x 35%)
Net Income after bonus after
₱75,000,000
2,480,916
72,519,084
25,318,679
₱47,137,405
Bonuses:
PAS 18 states that: An entity shall recognize the expected cost of profit-sharing and
bonus payments when, and only when:(a) the entity has a present legal or constructive obligation
to make such payments because of past events; and(b) a reliable estimate of the obligation can be
made.
Problem 13: MNO Inc. reported the following information in its long term liability portion of its
Statements of Financial Position for the period ended December 31, 2013:
12% Bonds Payable
10% Notes Payable – Bank
Deferred Taxes Liability, net
P5,500,000
2,500,000
340,000
Audit notes:
a. The bonds payable with face value of P5M was issued with a conversion =option into
20,000, P100 par value ordinary shares at any time up to its maturity on June 30, 2018.
There were issued on June 30, 2013 when the prevailing yield rate on similar debt
security without conversion option was 10%. The company recorded the transaction as a
debit to Cash and credit to Bonds Payable for the total consideration received. Interests
are being paid semi-annually every December 31, and June 30 and were recorded
appropriately. No further entries were made by the client affecting the carrying value of
the bonds.
Half of the bonds were retired on December 31, 2014 at par value. The prevailing yield
rate on similar debt instrument without the conversion option on this date was at 14%.
The transaction is yet to be recorded at year end.
b. The 10% note payable to the bank is dated September 1, 2013 and is payable at the rate
of P500,000, annually every September 1 of each year starting 2014. Interests are also
payable annually every September 1.
c. The deferred tax liability at the beginning of the year resulted to the following cumulative
temporary differences as of December 31, 2013:
Cumulative temporary difference creating
future taxable amount
Cumulative temporary difference creating
future deductible amount
P 1,050,000
200,000
At the end of the year the balance of the cumulative temporary differences were:
Cumulative temporary difference creating
future taxable amount
Cumulative temporary difference creating
future deductible amount
Income Tax is at 40%.
P 1,550,000
300,000
Required:
46. What is the equity portion of the Convertible Bonds?
a.
b.
None
113,914
c.
d.
120,921
500,000
47. How much should be recognized in the profit or loss as a result of the retirement of half
of the bonds at the end of 2014?
a.
b.
144,659
201,618
c.
d.
279,392
77,776
c.
d.
767,261
770,407
48. What is the total interest expense for 2014?
a.
b.
233,333
533,928
49. Assuming the total financial income after permanent difference is at P1,000,000, what is
the total current tax expense for 2014?
a.
100,000
c.
400,000
b.
240,000
d.
560,000
50. How much deferred tax should be presented separately in the non-current liability
portion of the Statement of Financial Position?
a.
b.
340,000
420,000
c.
d.
500,000
620,000
51. How much is the total long-term liability to be presented in the 2014 Statement of
Financial Position?
a.
b.
5,144,659
5,264,659
c.
d.
4,644,659
4,764,659
Solution and Explanation:
1-(1+.05)-10 = PV of ordinary annuity of 1 for 10 periods
.05
7.7217
-10
(1+.05)
= PV of 1 for 10 periods
0.6139
5,000,000 x 0.6139
5,000,000 x 6% x 7.7217
Liability component of
convertible bonds
P 3,069,500 Proceeds
2,316,510 Less: Liability component
Equity component of
P 5,386,010 convertible bonds
Date
Interest Paid
6/30/2013
12/31/2013
6/30/2014
12/31/2014
300,000
300,000
300,000
300,000
269,300
267,766
266,154
Total Carrying amount of bonds
P
Carrying amount of bonds retired
P
2,500,000 x 0.62275
2,500,000 x 6% x
5.38929
Fair Value of Bonds
Interest Expense
Premium
Amortization
30,700
32,234
33,846
P 2,365,269 Loss on retirement of Bonds
P
P 133,990
Carrying Value
5,386,010
5,355,310
5,323,076
5,289,230
5,289,230
÷2
2,644,415
P 1,556,875 Carrying Amount
808,394 Less: Fair Value of Bonds
Long Term Component of Notes Payable
Add: Short term Component
Total Notes Payable
x Interest Rate
Total Interest
P 5,500,000
5,386,010
2,500,000
500,000
3,000,000
10%
300,000
P 2,644,415
2,365,269
P 279,346
Interest on Notes for 2014
Less: Interest on Notes for 2013
Actual Interest Expense for
2014
500,000 x 8/12
300,000 x 4/12
P
P
Interest Expense of Bonds, Jan to Jun
Interest Expense of Bonds, Jul to Dec
Interest Expense of Notes
Total Interest Expense
267,766
266,154
233,333
767,235
Taxable income for 2014
Future taxable temporary amount, Jan 1, 2014
Future taxable temporary amount, Jan 1, 2014
Future taxable deductible amount, Dec 31, 2014
Future taxable deductible amount, Dec 31, 2014
Pre-tax Accounting Income
x Income tax rate
Total Current Tax Expense
Cumulative future taxable amount
× income tax rate
Non-current deferred tax
Carrying amount of bonds
Non-current Notes Payable –
Bank
Non-current deferred tax
Total Non-current liability
333,333
100,000
233,333
P
P
P
1,000,000
1,050,000
(1,550,000)
(200,000)
300,000
600,000
40%
240,000
1,550,000
40%
620,000
2,644,415
1, 500,000
620,000
4,764,415
The equity component is the residual amount between the proceeds and the liability component of the
financial instrument. According to par 15 of PAS 32:
“The issuer of a financial instrument shall classify the instrument, or its component parts, on initial
recognition as a financial liability, a financial asset or an equity instrument in accordance with the
substance of the contractual arrangement and the definitions of a financial liability, a financial asset
and an equity instrument”.
The process in computing the gain or loss in early retirement of the convertible bonds is in
accordance with PAS 32 AG33 which states that
“When an entity extinguishes a convertible instrument before maturity through an early redemption
or repurchase in which the original conversion privileges are unchanged, the entity allocates the
consideration paid and any transaction costs for the repurchase or redemption to the liability and
equity components of the instrument at the date of the transaction. The method used in allocating the
consideration paid and transaction costs to the separate components is consistent with that used in
the original allocation to the separate components of the proceeds received by the entity when the
convertible instrument was issued, in accordance with paragraphs 28–32.”
According to the book of Uberita, C., Practical Accounting I (2015)
When convertible debt instrument id retired prior to maturity, the total redemption price or
repurchase price and any transaction costs should be allocated between the liability component and
the equity component.
He further explained that “the reason why the allocation process is needed is consistent with that
used in the original allocation to separate components of the proceeds received when the convertible
instrument was issued. Any amount of gain or loss related to the equity component is recognized in
the profit or loss statement while the gain or loss related to the equity component is recognized in the
equity.”
The initial measurement to notes payable is in accordance to the PFRS 9 which states that “in the
case of a financial asset not at fair value through profit or loss, transaction costs that are directly
attributable to the acquisition of the financial asset”
Deferred tax taxes are measured in accordance to par 5 of PAS 12 which states that,
“Deferred tax liabilities are the amounts of income taxes payable in future periods in respect of
taxable temporary differences.
Deferred tax assets are the amounts of income taxes recoverable in future periods in respect of:
(a) deductible temporary differences;
(b) the carryforward of unused tax losses; and
(c) the carryforward of unused tax credits.
Temporary differences are differences between the carrying amount of an asset or liability in the
statement of financial position and its tax base. Temporary differences may be either:
(a) taxable temporary differences, which are temporary differences that will result in taxable amounts
in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or
liability is recovered or settled; or
(b) deductible temporary differences, which are temporary differences that will result in amounts that
are deductible in determining taxable profit (tax loss) of future periods when the carrying amount of
the asset or liability is recovered or settled.
The tax base of an asset or liability is the amount attributed to that asset or liability for tax
purposes.”
Presentation is liabilities should be presented in the Financial position as current and non-current
according to PAS 1 par. 60 to 61
“An entity shall present current and non-current assets, and current and non-current liabilities, as
separate classifications in its statement of financial position”
“an entity shall disclose the amount expected to be recovered or settled after more than twelve
months for each asset and liability line item that combines amounts expected to be recovered or
settled:
(a) no more than twelve months after the reporting period, and
(b) more than twelve months after the reporting period”
Liabilities that do not qualify as Current liability shall be classified as Non-current in accordance to
the criteria os PAS 1 par. 69
“An entity shall classify a liability as current when:
(a) it expects to settle the liability in its normal operating cycle;
(b) it holds the liability primarily for the purpose of trading;
(c) the liability is due to be settled within twelve months after the reporting period; or
(d) it does not have an unconditional right to defer settlement of the liability for at least twelve
months after the reporting period (see paragraph 73). Terms of a liability that could, at the option of
the counterparty, result in its settlement by the issue of equity instruments do not affect its
classification.
An entity shall classify all other liabilities as non-current.”
PROBLEM 14: On January 1,2014 KURT CORP. Issued a 3 year, 4,000 convertible bonds at
face value of P 1,000 per bond. Interest is to be paid annually in arrears at the stated coupon rate
of 6%. Each bond is convertible, at the holder’s option, into P40, P10 par value ordinary shares
at any time up to maturity. On the date of issuance, the prevailing market interest rate for similar
debt without the conversion privilege was 9%. On the same date, the market price of one
common share was P12.
52. What is the equity component of the compound instrument?
a. 110,091
b. 211,093
c. 303,755
d. 388,766
Solution:
PV Factor of 1
(1+9%)^-3
PV ordinary annuity
1-(1+9%)^-3/9%
Carrying Amount
Face amount
PV amount
Equity component
Php 3,088,734
607,511
Php 3,696,245
Php 4,000,000
(3,696,245)
Php 303,755
Explanation:
IFRS 9 deals with the measurement of financial assets and financial liabilities. Equity
instruments are instruments that evidence a residual interest in the assets of an entity after
deducting all of its liabilities. Therefore, when the initial carrying amount of a compound
financial instrument is allocated to its equity and liability components, the equity component is
assigned the residual amount after deducting from the fair value of the instrument as a whole the
amount separately determined for the liability component.
53. What is the interest expense to be reported on Kurt Corp.’s income statement for the year
ended December 31, 2016?
a. 303,133
b. 332,662
c. 341,002
d. 350,092
Solution:
Jan 2014
Dec 2014
Dec 2015
Dec 2016
Interest Paid
Interest
Expense
Amortizatio
n
240,000
240,000
240,000
332,662
341,002
350,092
92,662
101,002
110,092
Carrying
amount
Php 3,696,245
3,788,907
3,889,909
4,000,000
Interest expense, Dec 2016 = 350,092
Explanation:
Interest expense is computed by multiplying the carrying value at the beginning of the year from
the effective or yield rate.
54. What is the credit to share premium account assuming that 3,000 of the bonds were
converted on January 1, 2016?
a. 1,510,432
b. 1,945,248
c. 2,017,432
d. 2,289,908
Solution:
Jan 2016, Beg balance
3,000/4000 x 3,889,909
Share premium conversion
(303,755 x 3000/4000
Total
Original share
Php 2,917,431
227,816
Php 3,145,247
(1,200,000)
(3,000 x 40 x 10)
Share premium issuance
Php 1,945,247
Explanation:
Under PAS32, paragraph AG35, An entity may amend the terms of a convertible instrument to
induce early conversion, for example by offering a more favourable conversion ratio or paying
other additional consideration in the event of conversion before a specified date. The difference,
at the date the terms are amended, between the fair value of the consideration the holder receives
on conversion of the instrument under the revised terms and the fair value of the consideration
the holder would have received under the original terms is recognised as a loss in profit or loss.
55. Assuming that on the issuance date, the company paid transactions costs totalling to
P151,469, and as a result the yield rate increased by 1.5%, what is the equity component of the
compound interest?
a. 292,253
Solution:
b. 303,755
PV Factor of 1
(1+10.5%)^-3
PV ordinary annuity
1-(1+10.5%)^3/10.5%
c. 443,722
d. 315,257
Php 2,964,648
591,630
Php 3,556,278
Face amount
PV Balance
Total
Issue cost
Equity component
Php 4,000,000
(3,556,278)
Php 443,722
(151,469)
Php 292,253
Explanation:
IFRS 9 deals with the measurement of financial assets and financial liabilities. Equity
instruments are instruments that evidence a residual interest in the assets of an entity after
deducting all of its liabilities. Therefore, when the initial carrying amount of a compound
financial instrument is allocated to its equity and liability components, the equity component is
assigned the residual amount after deducting from the fair value of the instrument as a whole the
amount separately determined for the liability component.
56. Using the assumption in previous item, and assuming all the 4,000 bonds were retired on
January 1, 2016 when the prevailing yield rate on the bonds without the conversion of option
was at 9%, at 4,000,000, what is the loss to be reported in the income statement?
a. 0
b. 52,804
c. 162,895
d. 330,275
Solution:
Jan 2014
Dec 2014
Dec 2015
Interest Paid
Interest
Expense
Amortizatio
n
240,000
240,000
373,409
387,417
133,409
147,417
Bonds with conversion option
Bonds w/out conversion option
(see solution #53)
Loss
Carrying
amount
Php 3,556,278
3,689,687
3,837,104
Php 3,837,104
(3,889,909)
Php 52,805
Explanation:
According to PAS 32,paragraph AG31, A common form of compound financial instrument is a
debt instrument with an embedded conversion option, such as a bond convertible into ordinary
shares of the issuer, and without any other embedded derivative features. Paragraph 28 requires
the issuer of such a financial instrument to present the liability component and the equity
component separately in the statement of financial position, as follows
(a) The issuer’s obligation to make scheduled payments of interest and principal is a financial
liability that exists as long as the instrument is not converted. On initial recognition, the fair
value of the liability component is the present value of the contractually determined stream of
future cash flows discounted at the rate of interest applied at that time by the market to
instruments of comparable credit status and providing substantially the same cash flows, on the
same terms, but without the conversion option.
(b) The equity instrument is an embedded option to convert the liability into equity of the issuer.
This option has value on initial recognition even when it is out of the money.
Problem 16: On January 1, 2014, DEF Corp. starts leasing a building from JKL Leasing Co. for
a 10 year term. The lease agreement does not provide a provision for bargain purchase and that
the asset shall be reverted back to JKL after the lease term. The estimated useful life of the asset
is 15 year and its prevailing fair value on the inception of the lease was at P6.6M
The lease is payable at the rate of P 500,000 every January 1 and July 1 starting 2014. The
implicit rate of lease known to both parties was at 10% while the incremental borrowing rate was
at 12%.
DEF accounted for the lease as an operating lease charging Rentel Expense for the semi-annual
payments made.
Requirements:
60. What is the effect of any adjustments to be made to the 2014 net income?
a. 0
b. 345,734
c. 405,672
d. 248,639
61. What is the short term portion of any lease liability as of December 31, 2014?
a. 447,204
b. 425,908
c. 1,000,000
d. None
62. What is the carrying value of the Building as of December 31, 2014?
a. 0
Solution and Explanation:
b. 5,438,394
Entry Made
Rental Expense
Cash
c. 6,106,394
d. 5,888,394
Should Be Entry
1,000,000
1,000,000
Building
Lease Liability
Cash
Lease Liability
Cash
Interest Expense
Accrued interest payable
Interest Expense
Accrued interest payable
Depreciation Expense
Accumulated Depreciation
6,542,660
6,042,660
500,000
500,000
500,000
302,133
302,133
292,240
292,240
654,266
654,266
Adjusting Entry
Building
Interest Expense
Depreciation Expense
6,542,660
594,373
654,266
Rental Expense
Accrued interest payable 1,000,000
Accumulated
594,373
Depreciation
Lease Liability
654,266
5,542,660
1-(1+.05)-10x (1+.05)- = PV of ordinary annuity in advace
.05
13.08532
P 500,000 x 13.08532 = P 6,542,660
Date
Payment
Interest
Principal
1/1/2014
1/1/2014
500,000
--------500,000
7/1/2014
500,000
302,133
197,867
1/1/2015
500,000
292,240
207,760
7/1/2015
500,000
281,852
218,148
1/1/2016
500,000
270,944
229,056
Payment for 2015
Less: Payable in
2015
Short term Portion
Carrying Amount
Less: Depreciation
(6,542,660/10)
Carrying amount, 2014
Rent Income
Interest Expense Jan-Jun
Interest Expense Jan-Jun
Depreciation Expense
Decrease in Net Income
P
Carrying Value
6,542,660
6,042,660
5,844,793
5,637,032
5,418,884
5,189,828
1,000,000
292,240
281,852
425,908
P
P
6,542,660
P
654,266
5,888,394
P
P
1,000,000
(302,133)
(292,240)
(654,266)
(248,639)
The lease is classified as a finance lease because it clearly states in par. 8 of PAS 17 that
“A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to
ownership. A lease is classified as an operating lease if it does not transfer substantially all the risks and
rewards incidental to ownership.”
And in par. 10 further explains that
“Whether a lease is a finance lease or an operating lease depends on the substance of the transaction
rather than the form of the contract.* Examples of situations that individually or in combination would
normally lead to a lease being classified as a finance lease are:
(a) the lease transfers ownership of the asset to the lessee by the end of the lease term;
(b) the lessee has the option to purchase the asset at a price that is expected to be sufficiently lower than
the fair value at the date the option becomes exercisable for it to be reasonably certain, at the inception of
the lease, that the option will be exercised;
(c) the lease term is for the major part of the economic life of the asset even if title is not transferred;
(d) at the inception of the lease the present value of the minimum lease payments amounts to at least
substantially all of the fair value of the leased asset; and
(e) the leased assets are of such a specialized nature that only the lessee can use them without major
modifications.”
The building is measured at the fair value model approach because PAS 17 par. 20 states that
“At the commencement of the lease term, lessees shall recognise finance leases as assets and liabilities in
their statement of financial positions at amounts equal to the fair value of the leased property or, if lower,
the present value of the minimum lease payments, each determined at the inception of the lease.
The discount rate to be used in calculating the present value of the minimum lease payments is the interest
rate implicit in the lease, if this is practicable to determine; if not, the lessee’s incremental borrowing rate
shall be used. Any initial direct costs of the lessee are added to the amount recognised as an asset.”
PROBLEM 17: ABC Co. reported net income for the current year 2014 at P10,000,000 before
taxes. Included in the determination of the said net income were:
Permanent differences
Non-deductible expenses
Non-taxable income
Temporary differences
Accrued warranty expenses
Rental payments made in advance
Advance collections from customers
Provision for probable losses
P100,000
500,000
250,000
400,000
500,000
900,000
The income tax rate is 40% and is not expected to change in the future.
63. How much is the current tax expense?
a. 3,840,000
b. 4,340,000
c. 4,000,000
d. 3,340,000
c. 4,000,000
d. 3,340,000
64. How much is the total tax expense?
a. 3,840,000
b. 4,340,000
65. What is the total deferred tax asset to be presented in the 2014 Statement of Financial
Position?
a. 660,000
b. 160,000
c. 460,000
d. 360,000
66. What is the total deferred tax liability to be presented in the 2014 Statement of Financial
Position?
a. 660,000
b. 160,000
c. 460,000
d. 360,000
67. Assuming that the expected tax rate for the following year is 35%, what is the total tax
expense?
a. 3,902,500
b. 4,340,000
c. 4,777,500
d. 3,340,000
68. Assuming that the expected income tax rate for the following year is 35%, what is the total
deferred tax liability?
a. 140,000
b. 577,500
c. 660,000
d. 160,000
69. Assuming that the expected income tax rate for the following year is 35%, what is the total
deferred tax asset?
a. 140,000
b. 577,500
c. 660,000
d. 160,000
Solution and explanation:
Financial Income
Non-deductible expenses
Non-taxable income
Financial income after permanent differences
P10,000,000
100,000
(500,000)
P9,600,000
x 40%
P3,840,000
Total tax expense
Financial income after permanent differences
FDA:
Accrued warranty expenses
Advance collections from customers
Provision for probable loss
FTA:
Rental payments made in advance
Taxable income
P9,600,000
250,000
500,000
900,000
(400,000)
P10,850,000
x 40%
P4,340,000
Current tax expense
Deferred tax asset from FDA
1,650,000 x 40%
= P660,000
Deferred tax liability from FTA
400,000 x 40%
Current tax expense
Deferred tax benefit (1,650,000 x 35%)
Deferred tax expense (400,000 x 35%)
Total tax expense
Deferred tax asset from FDA
Deferred tax liability from FTA
= P160,000
P4,340,000
(577,500)
140,000
P3,902,500
1,650,000 x 35%
400,000 x 35%
= 577,500
= 140,000
PAS 12, paragraph 70, provides that when an entity makes a distinction between current and
noncurrent assets and liabilities, it shall not classify deferred tax assets as current assets and
deferred tax liabilities as current liabilities.
A deferred tax asset shall accordingly be classified as noncurrent asset and a deferred tax liability
shall be classified as noncurrent liability regardless of reversal period.
A deferred tax asset or deferred tax liability shall not be discounted.
PAS 12, paragraph 74, provides that an entity shall offset a deferred tax asset against a deferred
tax liability when the deferred tax asset and deferred tax liability relate to income taxes levied by
the same tax authority and when the entity has a legal enforceable right to set off a current tax
asset against a current tax liability.
A deferred tax liability or deferred tax asset shall be measured using the tax rate that has been
enacted by the end of the reporting period and expected to apply to the period when the asset is
realized or the liability is settled.
PROBLEM 18. XYZ Co. reported net income for the current year 2014 at ₱5,000,000 before
taxes. Included in the determination of the said income were:
Permanent differences
Non-deductible expenses
Non-taxable income
Temporary differences at the beginning of the year
Cumulative temporary difference creating future
deductible amount
Cumulative temporary difference creating future
taxable amount
Temporary differences at the end of the year
Cumulative temporary difference creating future
deductible amount
Cumulative temporary difference creating future
₱150,000
50,000
₱1,200,000
800,000
₱1,600,000
taxable amount
500,000
The income tax rate is 40% and is not expected to change in the future.
70. How much is the current tax expense?
a. 2,320,000
b. 2,040,000
c. 2,000,000
d. 1,650,000
71. How much is the total tax expense?
a. 2,320,000
b. 2,040,000
c. 2,000,000
d. 1,650,000
72. What is the total deferred tax asset to be presented in the 2014 Statement of Financial
Position?
a. 480,000
b. 320,000
c. 640,000
d. 200,000
73. What is the total deferred tax liability to be presented in the 2014 Statement of Financial
Position?
a. 480,000
b. 320,000
c. 640,000
d. 200,000
Solution and explanation:
70.
Net Income before taxes
Non-deductible expenses
Non-taxable income
Increase in future deductible amount
At the end of the year
At the beginning of the year
Decrease in future taxable amount
At the beginning of the year
At the end of the year
Taxable Amount
x Tax Rate
Current Tax Expense
5,000,000
150,000
(50,000)
1,600,000
(1,200,000)
800,000
500,000
400,000
300,000
5,800,000
40%
2,320,000
71.
Net Income before taxes
Non-deductible expenses
Non-taxable income
Taxable Amount
x Tax rate
Total tax expense
5,000,000
150,000
(50,000)
5,100,000
40%
2,040,000
72.
Cumulative temporary difference creating future
deductible amount at the end of the year
x Tax Rate
Total deferred tax asset in 2014
1,600,000
40%
640,000
73.
Cumulative temporary difference creating future
taxable amount at the end of the year
X Tax Rate
Total Tax Liability in 2014
500,000
40%
200,000
,
Under IAS/PAS 12 paragraph 5, tax expense (tax income) is the aggregate amount included in
the determination of profit or loss for the period in respect of current tax and deferred tax.
Current taxis the amount of income taxes payable (recoverable) in respect of the taxable profit
(tax loss) for a period.
Deferred tax liabilities are the amounts of income taxes payable in future periods in respect of
taxable temporary differences.
Deferred tax assets are the amounts of income taxes recoverable in future periods in respect of:
a. Deductible temporary differences;
b. The carry forward of unused tax losses; and
c. The carry forward of unused tax credits.
Temporary differences are differences between the carrying amount of an asset or liability in the
statement of financial position and its tax base. Temporary differences may be either:
a. Taxable temporary differences , which are temporary differences that will result in
taxable amounts in determining taxable profit (tax loss) of future periods when the
carrying amount of the asset or liability is recovered or settled; or
b. Deductible temporary differences, which are temporary differences that will result in
amounts that are deductible in determining taxable profit (tax loss) of future periods
when the carrying amount of the asset or liability is recovered or settled.