CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES
CHAPTER 1
Current Liabilities, Provisions, and
Contingencies
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Learning Objectives
After reading this chapter, you should be able to
1. define liabilities and explain their essential characteristics;
2. identify the recognition criteria for liabilities;
3. distinguish current liabilities from non-current liabilities;
4. distinguish provision from contingent liabilities;
5. account for different liabilities after initial recognition;
6. measure current liabilities on the statement of financial position; and
7. identify required disclosure for current liabilities and contingencies .
CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES
DEFINITION AND NATURE OF LIABILITIES
The IASB’s Conceptual Framework for Financial Reporting defines liability as
“present obligation of an enterprise arising from past event, the settlement of which is
expected to result in an outflow from the enterprise of resources embodying economic
benefits.”
An obligation is a duty or responsibility to act or perform in a certain way which
may be legally enforceable as a consequence of a binding contract or statutory
requirement; or it may be an obligation acknowledge by an enterprise because other
parties are made to believe that it will carry out an undertaking or certain action.
An obligating event is one that results in an enterprise having no realistic
alternative to settling that obligation. An obligating event may be classified in either of
the following:
1. legal obligation or
2. constructive obligation
A legal obligation is one that derives from a contract (through its explicit or implicit
term), legislation, or other operation of law. Examples of liabilities that arise from legal
obligations are accounts payable (arising from a contract with a supplier), withholding
taxes payable and value added taxes payable (arising from legislation and other operation
of law).
A constructive obligation is one that derives from an enterprise’s actions whereby
an established pattern of past practice, published policies or a sufficiently specific current
statement, the enterprise has indicated to other parties that it will accept certain
responsibilities, and as a result, the enterprise has created a valid expectation on the part
of those other parties that it will discharge those responsibilities. Example of a
constructive obligation is provision for clean up costs where the enterprise has a widely
published policy of cleaning up all contamination that it causes.
The settlement of a present obligation involves the enterprise giving up resources
embodying economic benefits in order to satisfy the claim of the other party. Settlement
of a present obligation may occur in any of the following ways:
a. payment of cash;
b. transfer to other assets;
c. provision of services;
d. replacement of an obligation with another obligation; and
e. conversion of the obligation to equity.
In some exceptional cases, an obligation is settled through condonation by the
creditor.
CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES
An obligation always involves another party to whom the obligation is owed.
However, it is not necessary to know the identity of the party to whom the obligation is
owed for it to qualify as a liability.
RECOGNITION OF LIABILITIES
A liability is recoded and reported in the statement of financial position when the
following conditions are met:
1.
It is probable that an outflow of resources embodying economic
benefits will result from the settlement of a present obligation; and
2. The amount at which the settlement will take place can be
measured reliably.
An outflow of resources is considered probable when the event is more likely to
occur than not to occur (i.e., the probability of occurrence is more than 50%).
Provision Distinguish from Contingent Liabilities
Definition
Provision
Liability of uncertain timing
or amount
Recognition Recognized as a liability on
the face of the statement of
financial position.
Financial
Presented separately in the
Statement
statement of financial
Presentation position under liabilities
Contingent Liability
Either
a) a possible obligation that arises
from past events and whose
existence will be confirmed only by
the occurrence or non-occurrence
of one or more future events not
wholly within the control of the
enterprise; or
b) a present obligation that arises from
past events but is not recognized
because
 it is not probable that an
outflow of resources
embodying economic
benefits will be required to
settle the obligation; or
 the amount of the obligation
cannot be measured
reliably.
Not recognized as a liability on the face of
the statement of financial position.
Unless remote, disclosed in the notes to
financial statements
CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES
Obligation involving uncertainties are accounted for as presented below:
Record by debiting an
expense or a loss and
crediting a liability
STATUS
Reliably
measure
Not reliably
measure
Probable
Reasonably
Possible
Remote
Disclose in the
notes to financial
statements
Ignore (Neither
recognize nor
disclose)




Contingent liabilities must be assessed continually to determine whether an outflow of
resources embodying economic benefits has become probable. If it becomes probable that
an outflow of future economic benefits will be required for an item previously dealt with
as a contingent liability, a provision is recognize in the financial statements of the period
in the change in probability occur (except in the extremely rare circumstances where no
reliable estimate can be made).
MEASUREMENT OF LIABILITIES
Liabilities are measured
1. at the amounts in exchanges (amount to be paid or amount discounted); or
2. by estimates of a definitive character when the amount of the liability cannot
be measured more precisely (provisions).
Measurement of Provisions

The amount recognized as a provision should be the best estimate of the
expenditure required to settle the obligation at the end of the reporting
period, considering
* judgment of the management of the enterprise;
* experience of similar transactions; or
* reports from independent experts.


If a single obligation is being measured, the amount to be recognized as
liability is the most likely outcome.
Where the amount of the obligation is still uncertain as of the end of the
reporting period, but the obligation is settled subsequently before the
CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES



issuance of the financial statements, the amount shown in the statement of
financial position is the amount actually settled subsequently.
Where the provision being measured involved a large population of items,
the obligation is estimated by weighting all possible outcomes by their
associated possibilities. 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.
Where the effect of the time value of money is material, the amount of a
provision should be the present value of the expenditures expected to be
required to settle the obligation.
Where some or all of the expenditures required to settle a provision is
expected to be reimbursed by another party, the reimbursement should be
recognized when, and only when, it is virtually certain that reimbursement
will be received if the enterprise settles the obligation. The reimbursement,
if virtually certain, should be treated as a separate asset. The amount
recognized for the reimbursement should not exceed the amount of the
provision.
Review of the Amount Previously Recognized as Provision
If based on subsequent review of the amount of the provision, there is a need to
adjust the previously recorded amount, the adjustment is treated as a change in
accounting estimate and would affect profit or loss of the current year. Thus, if based on
the review of the provision, the amount need to be decreased, the entry in a subsequent
reporting period is to debit the provision and credit an appropriate expense, loss or in
some cases, an income account.
If at the end of the reporting period, it is no longer probable that an outflow of
resources will be required to settle the obligation, the provision previously recognized
should be reversed.
CLASSIFICATION OF LIABILITIES
An enterprise shall classify a liability as current when (par. 69, IAS 1):
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.
CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES
Trade payables are generally classified as current liabilities even if they are not
due for settlement within twelve months from the end of the reporting period, because
settlement of these obligations is expected within the entity’s normal operating cycle.
Some liabilities include in this type are trade accounts and notes payable extended within
the usual credit terms of the supplier, and accruals for employee’s wages and other
operating costs.
No-trade obligations that are due for settlement within twelve months from the
end of the reporting period (regardless of the length of the operating cycle of the entity)
also form a part of current liabilities. These include short-term non-trade notes payable;
deposits and advances and portion of long term debt due within 12 months from the
reporting date.
Liabilities are held for trading if they are incurred principally for the purpose of
selling or repurchasing in the near term, or are part of the portfolio of identified financial
instruments that are managed together and for which there is evidence of a recent pattern
of actual profit-taking. These type of liabilities include deposits received by banks which
are held under trust funds and are invested by banks, in behalf of the depositors, in some
short-term financial instruments. Liabilities held for trading also include derivatives.
A long-term liability maturing within twelve months from the reporting date is
generally classified as part of current liabilities. However, if at the reporting date, the
entity has the right to defer settlement of the obligation for a period of more than twelve
months from such date, the liability shall be classified as non-current. The right to
postpone the settlement of the obligation may arise because of refinancing agreement
entered into by the enterprise. Refinancing takes the form of either extending the maturity
date or entering into a borrowing transaction, proceeds of which will be used to settle the
maturing obligation.
The currently maturing obligation shall be reported as non-current only if the
agreement to refinance is completed on or before the reporting date. If the agreement to
refinance is completed after the reporting period, even before the issuance of the financial
statements, the maturing obligation shall be classified as current, because as of the end of
the reporting date, the enterprise has no right yet to defer the settlement of the liability.
Likewise, if an entity expects, and has the discretion, to refinance or roll over an
obligation for more than twelve months after the reporting date under an existing loan
facility, it classifies the obligation as non-current, even if it would be due within a short
period.
Furthermore, when an entity breaches an undertaking under a long-term loan
agreement on or before the reporting date with the effect that the liability becomes
payable on demand, the liability is classified as current, even if the lender has agreed,
after the reporting period and before the authorization of the financial statement for issue,
not to demand payment as a current because, at the reporting date, the entity does not
have an unconditional right to defer its settlement for at least twelve months after that
date.
CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES
However, the liability is classified as non-current if the lender agreed at or before
the reporting date to provide a grace period ending at least twelve months from that date,
within which the entity can rectify the breach and during which the lender cannot demand
immediate payment.
Presentation Based on Liquidity
Assets and liabilities are classified into current and non-current on the face of the
financial statement (general rule). An exception to this rule applies when the enterprise
believes that presentation based on liquidity provides information that is more reliable
and more relevant. When this exception applies, an entity shall present all assets and
liabilities in order of liquidity.
Whichever method is adopted for the presentation of assets and liabilities, IAS 1
requires for each asset and liability that combines 1). Amounts expected to be recovered
or settled within twelve months from the reporting date and 2). Amounts expected to be
recovered or settled more than twelve months after the reporting date disclosure of that
amount expected to be recovered or settled after more than twelve months.
EXAMPLES OF CURRENT LIABILITIES
The major items usually found under the current liabilities section of the
statement of financial position include:






Accounts Payable
Short-term Notes Payable
Acceptance Payable
Liabilities Under Trust
Receipt
Deposits and Advances
Current Portion of Longterm Debt






Accrued Liabilities
Income Tax Payable
Dividends Payable
Credit Balances in Costumer’s
Account
Deferred Revenue
Provision expected to be
settled within 12 months
EXAMPLES OF NON-CURRENT LIABILITIES
All liabilities not classified as current are non-current liabilities. These include
obligations arising from financing of long-term needs such as:

Bonds Payable


Mortgage Loans Payable


Long Term Notes Payable
Liability under Finance Leases
not due within 12 months
Long-term Deferred Revenue
CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES
ACCOUNTING FOR DIFFERENT CURRENT LIABILITIES
ACCOUNTS PAYABLE
A liabilities arising from the purchase of goods, materials, or services on an open
charge-account basis is called accounts payable or trade accounts payable. The credit
time period generally varies from 30 to 120 days without any interest being charged on
the deferred payment. Most accounting system is designed to record liabilities for
purchases of goods are received, or particularly, when the invoices are received from the
supplier.
Methods of Accounting for Cash Discounts
Gross method
Purchases account and
the Accounts Payable are
recorded at the gross invoice
price. A cash discount taken on
purchases is recorded upon
payment as purchase discount.
Any balance of purchase
discounts is reported in profit or
loss as deduction from gross
purchases.
Net method
Purchases and Accounts
Payable are initially recorded at
invoice price less the cash
discount available. A cash
discount not taken is recorded as
purchase discount lost, which is
reported in profit or loss as part
of finance cost.
NOTES PAYABLE
Note Bearing a Realistic Interest Rate
A promissory note is a written promise to pay a certain sum of money to the
bearer at a designated future time. The notes may arise out of either a trade situation
(purchase of goods or services on credit) or the borrowing of money from a bank, or
other transactions.
Accounting for the issuance of interest bearing note is relatively straightforward.
Since the note is interest bearing (and assuming that the stated rate approximates the
prevailing market rate for similar obligations), the present value of the note at the time of
its issuance is its face value. The issuance of such a note is recorded as follows (assume
an issuance in settlement of an overdue trade discount):
Accounts Payable
Notes Payable
XX
XX
CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES
At maturity date, payment is made for the principal amount plus interest for the
entire term of the note, as follows:
Notes Payable
Interest Expense
Cash
XX
XX
XX
If the note is still outstanding at the end of the accounting period, an accrued
interest should be recorded for the period from the date of issuance of the note to the end
of the accounting period. Accrual of interest is recorded as
Interest Expense
Interest Payable
XX
XX
This adjusting entry may be reversed at the beginning of the new accounting
period so that the subsequent payment of the note and interest may be recorded in the
usual manner, debiting Notes Payable for the principal and Interest Expense for the total
interest paid.
Non – Interest Bearing Note
Accounting for a non-interest-bearing note is slightly more complex. A noninterest-bearing note does not explicitly state an interest rate on the face of the note. It
does not mean, that there is no interest imputed on the original obligation. A non-interest
bearing note is simply written in a form where the interest is imputed on the face value of
the note. Thus, the face value represents the present value of the obligation plus the
imputed interest for the term of the note.
The present value of the non-interest bearing note is the amount of cash received,
or the fair value of goods and services received. If the note is issued in exchange for
goods and services whose fair value cannot be reliably determined, the note is initially
measured based on the prevailing market rate of interest for a similar obligation. The
discounted amount (face value less an imputed interest) of the note should be used
initially to record the liability. The Notes Payable account is credited equal to the face
value of the note and a corresponding debit is made to the account Discount on Notes
Payable. The net credit account (Notes Payable less Discount on Notes Payable) is the
initial amortized cost of the liability. Interest expense is then recognized over the term of
the note, using the effective interest method, as an adjustment of this discounted amount.
This is done by charging Interest Expense and crediting Discount on Notes Payable.
At reporting date, the balance of discount on notes payable is deducted from the
dace value of the note to arrive at the amortized cost of the note to be presented on the
statement of financial position. The balance of the discount represents interest expense
over the remaining term of the note.
CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES
Note Bearing an Unrealistic Interest Rate
When the interest rate appearing on the face of the note is significantly different
from the market rate of similar notes, or when the consideration received on account of
the note issued has a fair value which is significantly different from the face value of the
note, the note bears an unrealistic interest rate. In such cases, the note and the interest to
be paid based on the stated rate are discounted at the market rate of interest on the date of
the issuance.
If the rate stated on the face of the note is higher than the market rate of interest,
the discounted amount is higher than the face value of the note, resulting in premium on
notes payable. It the rate stated on the face of the note is lower than the market rate of
interest; the discounted amount is lower than the note’s face value, resulting in discount
on notes payable.
STATED RATE < MARKET RATE = DISCOUNT
STATED RATE > MARKET RATE = PREMIUM
ACCRUED LIABILITIES
Accrued liabilities consist of obligations for expenses incurred on or before the
end of the reporting period but payable at a later date. Accrued liabilities include those
payables to specific persons and determinable with reasonably accuracy. They also
include provisions. Common examples are accrued salaries, accrued interest, accrued
rentals and accrued taxes. An accrued liability is taken up as an adjustment at year-end by
charging an expense account and crediting an accrued liability account.
WARRANTY
Home appliances 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 liability is incurred.
There are two approaches followed in accounting for warranty cost, namely
● “accrual” approach
▬ it has the soundest theoretical support because it properly matches cost with
revenue.
● “expense as incurred” approach.
▬ it is the approach of expensing warranty cost only when actually incurred.
CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES
PREMIUMS
These are articles of value such as toys, dishes, and other goods and in some cases
cash payments are given to customers as result of past sales or sales promotion activities.
In order to increase the sale of their products, entities offer premiums to
customers in return for product labels and coupons.
Accordingly, when the merchandise is sold, an accounting liability for the future
distribution of the premium arises and should be given accounting recognition.
The accounting procedures for the acquisition of premiums and recognition of the
premium liability are as follows:
1. When the premiums are purchased:
Premiums
Cash
XX
XX
2. When the premiums are distributed to customers:
Premium Expense
Premiums
XX
XX
3. At the end of the year, if premiums are still outstanding:
Premium Expense
XX
Estimated Premium Liability
XX
CUSTOMER LOYALTY PROGRAM
It is generally chosen to reward customers for past purchases and to provide them with
incentives to make further purchases.
If a customer buys goods or services, the entity grants the customer award credits
often described as “points”. The entity can redeem the “points” by distributing to the
customer free or discounted goods or services.
BONUSES
Large entities often compensate key officers and employees by way of bonus for
superior income realized during the year.
The main purpose of this scheme is to motivate officers and employees by
directly relating their well-being to the success of the entity.
CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES
This compensation plan results in liability that must be measured and reported in the
financial statement. The bonus computation usually has four variations:
1. Bonus is expressed as a certain percent of income before bonus and before tax.
2. Bonus is expressed as a certain percent of income after bonus but before tax.
3. Bonus is expressed as a certain percent of income after bonus and after tax.
4. Bonus is expressed as a certain percent of income after tax but before bonus.
UNEARNED REVENUE
Deferred revenue or unearned revenue is in come already received but not yet
earned. Deferred revenue may be realizable within one year or in more than one year
from the end of the reporting period.
If the deferred revenue is realizable within one year, it is a current liability. Typical
examples of current deferred revenue are unearned interest income, unearned rental
income and unearned subscription revenue.
If the deferred revenue is realizable in more than one year, it is classified as noncurrent
liability.
Typical examples of noncurrent deferred revenue are unearned from long-term service
contracts and long-term leasehold advances.
Under nominal approach/income approach, the entry for the advance collection of
revenue is:
Cash
XX
Revenue
XX
Under liability method, the entry for the advance collection of revenue is:
Cash
XX
Unearned Revenue
XX
CHECK/GIFT CERTIFICATES
Many megamalls, department stores and supermarkets sell gift certificates which
are redeemable in merchandise. The accounting procedures are:
CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES
1. When the gift certificates are sold:
Cash
XX
Gift Certificate Payable
XX
2. When the gift certificate are redeemed:
Gift Certificate Payable
Sales
XX
XX
3. When the gift certificate expire:
Gift Certificate Payable
XX
Forfeited Gift Certificates
XX
CURRENT PORTION OF LONG-TERM DEBT
The portion of long term debt that is due within 12 months after the reporting
period is classified as part of current liabilities. Examples are currently maturing portion
of bonds, mortgage notes, and other long-term indebtedness. However, the currently
maturing portion of the debt, in which the company has the discretion to refinance or roll
over within a period of more than 12 months after the reporting period shall continue to
be classified as non-current, based on the earlier discussion within this chapter.
COVENANTS
These are often attached to borrowing agreements which represent undertaking by the
borrower.
These covenants are actually restrictions on the borrower as to undertaking further
borrowings, paying dividends, maintaining specified level of working capital and so forth.
BREACH OF COVENANTS
Under this covenants, if certain conditions relating to the borrower’s financial
situation are breached, the liability becomes payable on demand.
PAS 1 provide that such liability is classified as current even if the ledger has agreed,
after the reporting period and before the statements are authorized for issue, not to
demand payment as a consequence of the breach.
The liability classified current because at the end of the reporting period, the entity does
not have an unconditional right to defer its settlement for at least twelve months after that
date.
CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES
However the liability is classified as noncurrent if the ledger has agreed on or before the
end of the reporting period to provide a grace period ending at least twelve months after
that date.
In this context, a grace period within which the entity can rectify the breach and during
which the lender cannot demand immediate repayment.
PRESENTATION OF CURRENT LIABILITIES
PAS 1 states that as a minimum, the face of the statement of financial position shall
include the following line items for current liabilities:
a.
b.
c.
d.
e.
Trade and other payables
Current provisions
Short-term borrowing
Current portion of long-term debt
Current tax liability
The term “trade and other payables” is a line term for accounts payable, notes payable,
accrued interest on notes payable, dividends payable and accrued expenses.
ESTIMATED LIABILITIES
Are obligations which exist at the end of reporting period although their amount is
not definite. Estimated liabilities also are either current or noncurrent in nature.
Examples include estimated liability for premium, award points, warranties, gift
certificate and bonus.
CONTINGENT ASSET
A contingent asset is a possible asset that arises from past events and whose
existence will be confirmed only by the occurrence or non-occurrence of one or more
uncertain future events not wholly within the control of the enterprise. An example is a
claim that an enterprise is pursuing through legal processes, where the outcome is
uncertain.
Contingent assets are not recognized in the financial statements since this may in
the result in the recognition of income that may never be realized. They are continuously
assessed to ensure that developments are appropriately reflected in the financial
statements. Where the inflow of economic benefits is probable, the contingent asset is
disclosed. However, when the realization of income is virtually certain, the related asset
is not a contingency anymore and its recognition is appropriate.
CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES
DISCLOSURE REQUIREMENTS
1. For each class of provision, an entity should disclose:








Carrying amount at the beginning and end of the period;
Additional provisions made in the period, including increases to existing
provisions;
Amounts used during the period;
Unused amounts reversed during the period;
The increase during the period in the discounted amount arising from the
passage of time and the effect of any change in the discount rate;
A brief description of the nature of the obligation and the expected timing of
any resulting outflows of economic benefit;
An indication of the uncertainties about the amount or timing of the outflows;
The amount of any expected reimbursement, stating the amount of any asset
that has been recognized for that expected reimbursement.
2. For each class of contingent liability at the end of the reporting period, an entity
should disclose a brief description of the nature of the contingent liability.
3. Where an inflow of economic benefits is probable, an enterprise should disclose a
brief description of the nature of the contingent assets at the end of the reporting
period and, where practicable, an estimate of their financial effect.
CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES
QUESTIONS - THEORY
1. Which of the following is not a characteristic of a liability?
a. The obligation must be settled to an identified party
b. It is a present obligation that entails settlement by probable future transfer or
use of cash, goods or services.
c. The liability must be an unavoidable obligation.
d. The transaction or event creating the obligation must have already occurred.
2. Which of the following is a current liability
a.
b.
c.
d.
Dividends in arrears on preference share
A dividend payable in the form of additional ordinary shares
A cash dividend payable to preference shareholders
All of these
3. It is a marketing scheme whereby an entity grants award credits to customers and
the entity can redeem the award credits in exchange for free or discounted goods
or services.
a. Customer loyalty program
b. Premium plan
c. Marketing program
d. Loyalty program
4. A provision is an obligation that is uncertain as to
a.
b.
c.
d.
Amount
Yes
Yes
No
No
Existence
Yes
No
Yes
No
5. An outflow of resources embodying economic benefits is regarded as “probable”
when
a. The probability that the event will occur is greater than the probability that the
event will not occur.
b. The probability that the event will not occur is greater than the probability that
the event will occur
c. The probability that the event will occur is the same as the probability that the
event will not occur.
d. The probability that the event will occur is 50% likely.
6. Which of the following uncertainties is normally accrued?
a. Pending or threatened litigation
b. General or unspecified business risk
CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES
c. Obligations related to product warranties
d. Risk of property loss due to fire
7. Estimated liabilities are disclosed in financial statements by
a. Note to the financial statements
b. Showing the amount among the liabilities but not extending to the liability
total
c. An appropriate of retained earnings
d. Appropriate classifying them as regular liabilities in the statement of financial
position
8. A retail store received cash and issued gift certificates that are redeemable in
merchandise. The gift certificates lapse one year after they are issued. How would
the deferred revenue account be affected by the redemption and lapse of
certificated, respectively?
a.
b.
c.
d.
Decrease and No effect
Decrease and Decrease
No effect and No effect
No effect and Decrease
9. Magazine subscriptions collected in advance are treated as
a.
b.
c.
d.
A contra account to magazine subscription receivable
Deferred revenue in the liability section
Deferred revenue in the shareholder’s equity section
Magazine subscription refund in the income statement in the period collected
10. A provision shall be recognized when
I. An entity has a present obligation as a result of a pas event.
II. It is probable that an inflow of resources embodying economic benefits will be
required to settle the obligation.
III. The amount of the obligation can be measured reliably.
a.
b.
c.
d.
I and II only
I and III only
II and III only
I, II and III
ANSWERS – THEORY
1. A
2. D
3. A
4. A
5. B
6. C
7. A
8. B
9. C
10. B
CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES
QUESTION - PROBLEM
1. The effective interest on a 12-month zero-interest-bearing note payable of P300,000,
discounted at bank at 10% is
a. 11.11%
b. 10.87%
c. 10.00%
d. 9.09%
2. JEL 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, JEL 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. What amount of provision should be
accrued as liability?
a. 500,000
b. 800,000
c. 300,000
d.
0
3. JPP Company sells contract agreeing to service equipment for a 3 year period.
Information for the year ended December 31,2012 is as follows:
Cash receipts from service contract sold
Service contract revenue recognized
Unearned service contract revenue, 1/1/12
P960, 000
780,000
540,000
In its December 31, 2012 statement of financial position, what amount should JPP
report as unearned service contract revenue?
a.
b.
c.
d.
240,000
390,000
550,000
720,000
4. At December 31, 2012, CCL Company had 1,000 gift certificate outstanding, which
had been sold to costumers during 2012 for P750. CCL operates on a gross margin of
60%. How much revenue pertaining to the 1,000 outstanding gift certificates should
be deferred at December 31, 2012?
a. 750,000
b. 450,000
c. 300,000
d.
0
CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES
5. TOSHIBA Company sells equipment service contracts that cover a 2-year period.
The sale of each contract is P600. TOSHIBA’s past experience is that, of the total
pesos spent for repairs on service contracts, 40% is incurred evenly during the first
contract year and 60% evenly during the second contract year. TOSHIBA sold 1,000
contracts evenly throughout 2011.
In its December 31, 2011 statement of financial position, what amount should Nokia
report as deferred service revenue?
a.
b.
c.
d.
540,000
480,000
360,000
300,000
6. ABC Company’s promotional program indicated that for every 10 box tops returned to ABC,
customers receive a perfume. Manny estimates that only 60% of the box tops reaching the
market will be redeemed. Additional information is as follows:
Sales of product
Perfumes purchased
Perfumes distributed
UNITS
AMOUNT
100,000
5,500
4,500
30,000,000
4,125,000
What is the amount of year-end estimated liability associated with this promotion?
a.
b.
c.
d.
4,125,000
3,000,000
4,500,000
1,500,000
7. During 2011, NEWTECH Company introduced a new product carrying a 2-year warranty
against defects. The estimated warranty costs related to peso sales are 3% within 12 months
following sale and 4% in the second 12 months following sale. Sales are P7,500,000 for
2011 and P9,000,000 for 2012. Actual warranty expenditures are P185,000 for 2011 and
P400,000 for 2012. On December 31, 2012, what is the estimated warranty liability?
a. 100,000
b. 450,000
c. 570,000
d.
0
8. COMTECH Inc., sells computers that carry a 3 year warranty against manufacturer’s defects.
Based on company experience, warranty costs were estimated at P300 per computer. During
2012, COMTECH sold 24,000 computers and paid warranty costs of P1,700,000.
In its profit or loss for the year ended December 31,2012, COMTECH should report
warranty expense of
a. 1,700,000
b. 2,400,000
c. 5,500,000
d. 7,200,000
CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES
9. Assuming that the company’s operation started in 2012, what is the liability for the warranty
reported by COMTECH at December 31, 2012? Use the information given in no. 8
a.
b.
c.
d.
1,700,000
2,400,000
5,500,000
7,200,000
10. MTE Company has an incentive compensation plan under which a branch manager received
10% of the branch income after deduction of the bonus but before deduction of income tax.
Branch income for the current before the bonus and income tax was P1,650,000. The tax rate
is 30%. What is the bonus for the current year?
a.
b.
c.
d.
126,000
150,000
165,000
180,000
ANSWERS – PROBLEMS
1. Proceeds = 100% - 10%
= 90%
Effective interest = 10%/90%
= 11.11%
2. Environmental cost
Litigation cost
Total accrued liability
P500,000
300,000
P800,000
3. Cash receipts from service contract sold
Less: Service contract revenue recognized
Add: Unearned service contract revenue, 1/1/12
Unearned service contract revenue
P960, 000
(780,000)
540,000
P720,000
4. Gift certificate Outstanding
Multiply by Amount of GCO
Revenue
1,000
x 750
P750,000
5. First contract year (40% x 600,000)
Second contract year (60% x 600,000)
240,000
360,000
Total contracts sold in 2011
600,000
CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES
Since the contracts are sold evenly, only ½ of the 40% is earned in 2011 and
½ will be earned in 2012. ½ of the 60% will be earned in 2012 and ½ will be
earned in 2013.
Thus, the deferred service contract revenue on December 31, 2011 is
computed as follows:
Total contracts sold (1,000 x 600)
Less: Contracts earned in 2011(240,000 x ½)
600,000
(120,000)
Deferred service revenue - December 31, 2011
P480,000
Service contract revenue earned in 2012:
Remaining ½ of the first contract year
(240,000 x ½)
First ½ of the second contract year
(360,000 x ½)
120,000
180,000
Total service contract revenue earned in 2012
300,000
6. Perfumes to be distributed (100,000 x 60% / 10)
Perfumes distributed
6,000
4,000
Balance
Multiply by cost of Perfumes
2,000
x 750
Estimated liability
P1,500,000
7. Warranty expense:
2011 (7,500,000 x 7%)
2012 (9,000,000 x 7%)
525,000
630,000
1,155,000
Actual warranty expenditures:
2011
2012
185,000
400,000
585,000
Warranty liability – December 31, 2012
8. Computers Sold
Multiply by Estimated Warranty Cost
Warranty Expense
P570,000
24,000
x 300
P7,200,000
CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES
9. Warranty Expense
Less: Warranty Costs
P7,200,000
1,700,000
P5,500,000
10. Income after bonus before tax (1,650,000/110%)
1,500,000
Bonus (10% x 1,500,000)
P150,000
CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES
REFERENCES:
 Intermediate Accounting; Volume 2; 2012 edition;
By: Nenita S. Robles and Patricia M. Empleo
 Financial Accounting; Volume 2; 2012 edition;
By: Conrado T. Valix, Jose F. Peralta and Christian Aris M. Valix
 Practical Accounting; Volume 1; 2011 edition;
By: Conrado T. Valix and Christian Aris M. Valix
 Theory of Accounts; Volume 2; 2012 edition;
By: Conrado T. Valix and Christian Aris M. Valix