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Accounting for Current Liabilities
and Contingencies
Current Liabilities
Question 1
Unearned rent revenue would normally appear in the statement of financial position as a current liability.
Question 2
The initial fair value of a financial liability is defined as the amount for which a liability is paid in an orderly transaction between market participants at the measurement date.
Question 3
In the current liabilities section of the statement of financial position, employment taxes that are due for settlement in 15 months' time should be presented.
Question 4
Collections received for service contracts should be recorded as an increase in a deferred revenue account.
Question 5
The relationship between present value and the concept of a liability is that present value is used to measure certain liabilities.
Question 6
After initial recognition, an entity shall measure a financial liability at amortized cost using the effective interest method.
Question 7
The amount that should be reported as current liabilities at December 31, 2016 for FB Company is P8,175,.
Question 8
The amount Jel Company should report as a liability for deposits on returnable containers at December 31, 2016 is P337,.
Question 9
The general manager's bonus for 2016 under Alternative 1 is P640,.
Question 10
A customer loyalty program 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.
Question 11
The amounts that should be reported respectively as sales taxes payable and occupancy taxes payable on December 31, 2013 for Marie Hotel are P540,000 and P820,.
Question 12
The entity should recognize the warranty costs when the appliances are sold.
Question 13
The amount Burgundy Company should report as accrued salaries at June 2016 is P369,.
Question 14
The amount Jek Company should report as accounts payable in its December 31, 2016 statement of financial position is P569,.
Question 15
The amount that should be reported as deferred revenue from subscription on December 31, 2014 for Hart Company is P3,600,.
Question 16
The liability for outstanding gift certificates at December 31, 2016 for Mega Department Store is P760,.
Question 17
Estimated liabilities are disclosed in financial statements by note to the financial statements.
Question 18
The liability for customer advances at the end of the year for Dexter Company is P4,600,.
Principal Classifications of Liabilities
The principal classifications of liabilities are:
Current liabilities Noncurrent liabilities Deferred revenue
Advance Payment for Special Order Goods
An advance payment for special order goods that are to be manufactured and delivered within six months is reported in the statement of financial position as a current liability.
Unearned Service Contract Revenue
Ryan Company sells major household appliance service contracts for cash. Cash receipts from contracts are credited to unearned service contract revenue. On December 31, 2014, the unearned service contract revenue balance was P720,000 before year-end adjustment. Outstanding service contracts on December 31, 2014 expire as follows: During 2015: P150, During 2016: P225, During 2017: P100, The amount that should be reported as unearned service contract revenue on December 31, 2014 is P475,000.
Hugo Trading's Current Liabilities
Hugo Trading's unadjusted trial balance at December 31, 2016 included the following balances: Accounts receivable: P92, Accounts payable: P35, Bank notes payable: P600, Mortgage note payable: P1,200, The bank notes were issued on August 1, 2015, due on July 31, 2017, and pay 10% interest payable at maturity. The mortgage note was due on March 1, 2017, with interest at 9% paid up to December 31. Included in accounts receivable were two customers' accounts with credit balances totaling P18,000. On November 1, 2016, Hugo Trading rented a portion of its factory for P30,000 per year, payable in advance. The total current liabilities of Hugo Trading as of December 31, 2016 is P935,000.
Jag Company's Current Liabilities
Jag Company issued a new 3-year mortgage note for P2,000,000 on August 1, 2016 to pay off the mortgage note payable of P1,500,000 due on August 20, 2016. The bank notes are payable in semi-annual installments of P50,000 on February 1 and August 1, with 12% interest based on the outstanding balance. Accounts payable included an invoice of P65,000 for goods received on July 3, 2016. Jag Company has casual daily wage employees with an average weekly payroll of P15,000, with the last payment made on June 26, 2016. Jag Company is being sued by a dismissed employee, with the suit filed on April 1, 2016. Jag Company's sales for June 2016 were P3,640,000, inclusive of 12% VAT, with monthly remittance to the BIR on the 20th of the following month. The total income tax due for the fiscal year ended June 30, 2016 was P586,500, with quarterly remittances of P345,000 during the fiscal year. The total current liabilities of Jag Company as of June 30, 2016 is P2,589,150.
Classification of Notes Payable
Mazda Company had a 10% note payable issued on October 1, 2013, maturing on October 1, 2015, and a 12% note payable issued on March 1, 2013, maturing on March 1, 2015. The 2014 financial statements were issued on March 31, 2015. Under the loan agreement for the 10% note payable, the entity has the discretion to refinance the obligation for at least twelve months after December 31, 2014. On March 1, 2015, the entire P4,000,000 balance of the 12% note payable was refinanced through the issuance of a long-term obligation payable in a lump sum. The amount of the notes payable that should be classified as current on December 31, 2014 is P2,000,000.
Measurement of Consideration Allocated to Award Credits
The consideration allocated to the award credits is measured at the proportion of the fair value of the award credits relative to the total consideration received from the initial sale of the goods.
Classification of Certain Obligations as Current
Obligations that are classified as current even if they are expected to be settled after more than twelve months from the end of the reporting period include: - Income taxes payable - Dividends payable - Trade payables and accruals for employee and other operating costs - Bank overdrafts
The amount of unearned revenue reported in the financial statements depends on the specific facts and circumstances, such as the timing of revenue recognition and the entity's past experience.
Accrued Liabilities
Accrued liabilities represent expenses that have been incurred but not yet paid. Examples include:
Accrued interest payable Accrued advertising or rent expenses
The amount of accrued liabilities reported depends on the specific facts, such as the timing of payments and the entity's past experience.
Contingencies
A contingency is a possible asset or liability 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 entity.
Contingent liabilities are generally disclosed in the financial statements, unless the possibility of an outflow of resources is remote. Contingent assets are generally not recognized in the financial statements, but may be disclosed if the inflow of economic benefits is probable.
Provisions
A provision is a liability of uncertain timing or amount. For a provision to be recognized, the following criteria must be met:
There is a present obligation as a result of a past event. It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation. A reliable estimate can be made of the amount of the obligation.
Provisions may include warranties, restructuring costs, environmental remediation, and onerous contracts, among others.
Reimbursement of Provisions
When some or all of the expenditure required to settle a provision is expected to be reimbursed by another party, the reimbursement shall be recognized as a separate asset, but only when it is virtually certain that reimbursement will be received if the entity settles the obligation.
Examples and Calculations
The provided questions and examples cover a range of topics related to provisions and contingencies, including:
Accounting for customer loyalty programs Calculation of unearned revenue Determination of accrued liabilities Recognition and measurement of provisions, such as warranties and dismantling costs Identification and treatment of contingencies
The solutions demonstrate the application of the relevant principles and provide detailed calculations where appropriate.
Reimbursement of Provisions
Recognition of Reimbursement
The reimbursement shall be recognized only when it is virtually certain that the reimbursement will be received if the entity settles the obligation. The amount of the reimbursement shall not exceed the amount of the provision.
Presentation in the Income Statement
In the income statement, the expense relating to the provision may be presented net of the reimbursement.
Netting of Reimbursement
The reimbursement shall be 'netted' against the estimated liability for the provision.
Relocation Costs Provision
In May 2014, Cherry Company relocated an employee from the Manila head office to a branch in Zamboanga City. As of the end of the reporting period on June 30, 2014, the costs were estimated to be P350,000 analyzed as follows:
Provision for Relocation Costs
The amount that should be reported as provision for relocation costs on June 30, 2014 is P250,000.
P100,000 and 10% of products sold require major repairs costing P400,000. The appropriate discount factor for cash flows expected to occur on December 31, 2018 is 0.94. An appropriate risk adjustment factor to reflect the uncertainties in the cash flow estimates is an increment of 6% to the probability weighted expected cash flows. What is the warranty expense to be recognized in 2017?
a. 498,200 b. 530,000 c. 514,100 d. 500,
Question 12
Iriga Company issued the 2013 financial statements on March 1, 2014. The following data are provided by the entity for the year ended December 31, 2013:
What amount should be recognized as provision on December 31, 2013?
a. 1,300,000 b. 1,750,000 c. 1,200,000 d. 1,600,
Question 13
When the provision involves a large population of items, the estimate of the amount:
a. Is determined as the individual most likely outcome. b. May be the individual most likely outcome adjusted for the effect of other possible outcomes. c. Is the midpoint of the possible outcomes.
Question 14
William Company operates a customer loyalty program. The entity grants loyalty points for goods purchased. The loyalty points can be used by the customers in exchange for goods of the entity. The points have no expiry date. During 2017, the entity issued 100,000 award credits and expects that 80% of these award credits shall be redeemed. The total stand-alone selling price of the award credits granted is reliably measured at P2,000,000. In 2017, the entity sold goods to customers for a total consideration of P8,000,000 based on stand-alone selling price. The award credits redeemed and the total award credits expected to be redeemed each year are as follows:
What is the revenue from points for 2017?
a. 480,000 b. 1,500,000 c. 1,600,000 d. 600,
Question 15
Where there is a continuous range of possible outcomes, and each point in that range is as likely as any other, the range to be used is the:
a. Summation of the minimum and maximum b. Midpoint c. Minimum d. Maximum
Question 16
Sam Company started business in 2015. It sells printers with a three-year warranty. Sam Company estimates its warranty cost as a percentage of peso sales. Based on past experience, it is estimated that 2% will be repaired during the first year of warranty, 4% will be repaired during the second year of warranty and 6% will be repaired in the third year. In 2015 and 2016, the company was able to sell 7,500 units and 8,400 units, respectively at a selling price of P5,000 per unit. The company also incurred actual repair costs of P53,000 and P1,176,000 in 2015 and 2016, respectively. What amount should Sam Company report as warranty expense in 2015?
a. P3,970,000 b. P5,040,000 c. P4,500,000 d. P7,834,
Question 17
Which is the correct definition of a provision?
a. A possible obligation arising from past events b. A liability which cannot be easily measured c. An obligation to transfer funds to an entity d. A liability of uncertain timing or amount
Question 18
Snoopy Company is engaged in the manufacture of chemicals that it exports other countries. On December 20, 2016, one of its storage tanks in the plant exploded. Unfortunately, one of its employees was caught by the accident and suffered severe burns all over his body. For damages sustained because of the explosion, the employee sued Snoopy Company and claimed an amount totaling P3 million for physical injuries sustained. The lawyer of Snoopy Company expects that the company will probably lose the lawsuit and estimates that the company may have to pay amount of P2.5 million. On March 10, 2017, upon advice of the lawyer, the injured employee offered to have an out-of-court settlement of P2 million. The offer was tendered on the same date and Snoopy accepted the offer on March 12, 2017 upon advice of its legal counsel. The financial statements for the year 2016 were issued on March 31, 2017. What amount should be reported by Snoopy Company as liability from the legal case at December 31, 2016?
a. P2,000,000 b. P0 c. P3,000,000 d. P2,500,
Question 19
On December 17, 2016, an explosion occurred at Action Fireworks plant in Bulacan causing extensive property damage to area buildings. Although no claims had yet been asserted against Action Fireworks by March 10, 2017, the management and counsel concluded that it is reasonably possible that Action Fireworks will be responsible for damages and that P2,500,000 would be a reasonable estimate of its liability. Action Fireworks P10 million comprehensive public liability policy has a P500,000 deductible clause. In
will have minor defect and 5% will have major defects. The provision for repairs required on December 31, 2016 is:
a. P100,
Question 23
Which of the following is required to be disclosed regarding risk and uncertainties that exist?
a. The potential impact of estimate when it is reasonably possible that the estimate will change in the future. b. A description of operations both within and outside of the home country. c. The potential impact of estimate when it is remotely possible that the estimate will change in the future. d. Factors causing an estimate to be sensitive.
Question 24
Des Moines Company introduced during 2015, a new television model with a two-year warranty against defects. Des Moines Company estimates the warranty costs at 2% of peso sales within 12 months following the sale and at 4% in the second 12 months following the sale. Sales and actual warranty expense for the year ended December 31, 2015 are P3,000,000 and P45,000, respectively, and for the year ended December 31, 2016 are P5,000,000 and P150,000, respectively. Des Moines Company should report an estimated warranty liability in its December 31, 2016 statement of financial position of:
a. P285,000 b. P50,000 c. P225,000 d. P85,
Question 25
An entity did not record an accrual for a present obligation but disclose the nature of the obligation and the range of the loss. How likely is the loss?
a. Certain b. Probable c. Reasonably possible d. Remote
Question 26
Which of the following is a characteristic of the accrual of warranty but not the sale of warranty?
a. Warranty liability b. Warranty expense c. Unearned warranty revenue d. Warranty revenue
Question 27
For an event to be an obligating event, it is necessary that the entity has no realistic alternative but to settle the obligation created by the event and this is the case only:
I. Where the settlement of the obligation can be enforced by law. II. Where the event creates valid expectation in other parties that the entity will discharge the obligation as in the case of a constructive obligation.
a. Either I or II b. II only c. Neither I nor II d. I only
Question 28
Electro Company gives warranties at the time of sale to purchasers of its product. The entity undertakes to make good by repair or replacement, manufacturing defects that become apparent within one year from the date of sale. Sales of P5,000,000 were made evenly throughout 2017. The expenditures for warranty repairs and replacements for the products sold in 2017 are expected to be made 50% in 2017 and 50% in 2018. The 2018 outflows of economic benefits related to the warranty will take place on December 31, 2018. The entity estimated that 75% of products sold require no warranty repairs, 15% of products sold require minor repairs costing P100,000 and 10% of products sold require major repairs costing P400,000. The appropriate discount factor for cash flows expected to occur on December 31, 2018 is 0.94. An appropriate risk adjustment factor to reflect the uncertainties in the cash flow estimates is an increment of 6% to the probability weighted expected cash flows. What is the warranty liability on December 31, 2017?
a. 250,000 b. 249,100 c. 265,000 d. 235,
Question 29
Which of the following statements is true in relation to recognition of a provision?
I. No provision is recognized for costs that need to be incurred to operate in the future. II. A provision for the decommissioning of an oil installation or a nuclear plant station shall be recognized to the extent that an entity is obliged to rectify damage already caused.
a. Neither I nor II b. II only c. Both I and II d. I only
Question 30
On November 1, 2016, Corn Company was awarded judgment of P3 million in connection with a lawsuit. Corn Company's attorneys feel that it is highly probable than an award will be upheld on appeal, but the judgment may be reduced by an estimated 40%. In addition to a footnote, what amount should be reported as a receivable in Corn Company's statement of financial position?
a. P0 b. P1,200,000 c. P1,800,000 d. P3,000,
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Therefore, the premium inventory (prepaid expense) reported at December 31, 2016 is P124,800.
Reporting Contingent Assets
An entity operates a plant in a foreign country, and the foreign government has indicated that the entity will receive a definite amount of compensation for the plant. The amount of compensation is less than the fair value but exceeds the carrying amount of the plant.
According to the information provided, the contingent asset should be reported in the notes to the financial statements.
Estimating Provisions
When the provision arises from a single obligation, the estimate of the amount: - Reflects the weighting of all possible outcomes by their associated probabilities.
Accounting for Restructuring Provisions
Helen Company decided to restructure its operations, including closing down Factory A and retrenchment of employees. On December 31, 2013, the following had occurred: Retrenched employees have left, and their accumulated entitlements have been paid. An amount of P1,000,000, representing a portion of the six months' wages for the retrenched employees, has still not been paid. Costs of P300,000 are expected to be incurred in transferring the remaining employees to their new work in Factory B. One employee, Juan Cruz, remains to complete administrative tasks relating to the closure of Factory A and the transfer of employees to Factory B.
The total amount that should be recognized as restructuring provision on December 31, 2013 is P1,500,000.
Reporting Contingent Liabilities
When a contingent liability is reasonably possible that the entity will have to pay the liability at a future date, it should be disclosed in the notes to the financial statements.
Accounting for Probable Liabilities
Mother, Inc. is being sued for illness caused to local residents due to negligence in permitting exposure to toxic chemicals.
Mother, Inc.'s lawyer states that it is probable that Mother, Inc. will lose the suit and be found liable for a judgment costing anywhere from P400,000 to P2,000,000.
In this case, Mother, Inc. should recognize a provision for the probable liability, with the amount reflecting the weighting of all possible outcomes by their associated probabilities.
Accounting for Contingencies and Provisions
Loss Contingencies
According to the given information, the entity should account for the loss contingencies as follows:
a. The entity should accrue a loss contingency of P1,200,000 and disclose an additional contingency of up to P800,000. This is because the amount of P1,200,000 is the most probable cost, which falls within the range of the lowest and highest possible costs. The excess of P800,000 (P2,000,000 - P1,200,000) should be disclosed as a contingent liability.
b. The entity should accrue a loss contingency of P400,000 and disclose an additional contingency of up to P1,600,000. This is because the most probable cost falls within the range of the lowest and highest possible costs.
c. The entity should accrue a loss contingency of P1,200,000 but not disclose any additional contingency. This is incorrect because the entity should disclose the additional contingency of up to P800,000 as per the requirements.
Warranty Expense Estimation
The Villa Company estimated the annual warranty expense at 8% of net sales. The following data is provided for the current year:
a. Net sales for the current year = P5,500,000 b. Net sales for the current year = P6,750,000 c. Net sales for the current year = P1,250,000 d. Net sales for the current year = P8,000,
Discount Rate for Provisions
The following statements regarding the discount rate for provisions are correct:
a. The discount rate is a post-tax discount rate. b. The discount rate does not reflect risk for which future cash flow estimates have already been adjusted. c. The discount rate reflects risk specific to the liability. d. The discount rate reflects the current market assessment of the time value of money.
Evaluation of Pending Litigation Liability
The following factors are considered when evaluating whether or not to record a liability for pending litigation:
a. The ability to make a reliable estimate of the amount of the loss. b. Time period in which the underlying cause of action occurred. c. The probability of an unfavorable outcome.
Contingent Liabilities
A contingent liability is:
a. An event which is not recognized because it is not probable that an outflow will be required or the amount cannot be reliably estimated. b. An estimated liability. c. A potential small liability. d. A potential large liability.
Obligating Event
An obligating event is an event that creates a legal or constructive obligation because the entity has no other realistic alternative but to settle the obligation.
Legal Obligations
A legal obligation is an obligation that is derived from all of the following, except:
a. Other operation of law b. A contract c. Legislation d. An established pattern of past practice
Premium Liability Estimation
In an effort to increase sales, Mills Company inaugurated a sales promotional campaign on June 30, 2014. The entity placed a coupon redeemable for a premium in each package of cereal sold. Each premium cost P20 and five coupons must be presented by a customer to receive a premium. The entity estimated that only 60% of the coupons issued will be redeemed. For the six months ended December 31, 2014, the following information is available:
a. The estimated liability for premium claims outstanding on December 31, 2014 is P169,000. b. The estimated liability for premium claims outstanding on December 31, 2014 is P384,000. c. The estimated liability for premium claims outstanding on December 31, 2014 is P288,000. d. The estimated liability for premium claims outstanding on December 31, 2014 is P224,000.
Accrual of Loss Contingency
On November 5, 2016, Tim Truck Rental Company was in an accident with an automobile driven by Jayson. Tim Truck received notice on January 12,
2017 of a lawsuit for P700,000 damages for personal injuries suffered by Jayson. Tim Truck's counsel believes it is probable that Jayson will be awarded an estimated amount in the range between P200,000 and P450, and that P300,000 is a best estimate of potential liability. Tim Truck's accounting year ends on December 31 and the 2016 financial statements were issued on March 2, 2017.
The amount of loss that Tim Truck Rental Company should accrue at December 31, 2016 is P300,000.
Provision for Relocation Costs
In May 2014, Cherry Company relocated an employee from the Manila head office to a branch in Zamboanga City. As of the end of the reporting period on June 30, 2014, the costs were estimated to be P350,000 analyzed as follows:
a. The amount reported as provision for relocation costs on June 30, 2014 is P140,000. b. The amount reported as provision for relocation costs on June 30, 2014 is P160,000. c. The amount reported as provision for relocation costs on June 30, 2014 is P240,000. d. The amount reported as provision for relocation costs on June 30, 2014 is P250,000.
Reporting of Litigation Gains
Hay Company won a litigation for P45,000 tripled to P135,000 to include punitive damages during January 2016. In an unrelated suit it filed, which is still on appeal by the defendant, Hay was awarded P145,000.
The amount Hay Company should report as pretax gain in its 2016 financial statements is P150,000.
Premium Liability Estimation
At the beginning of the current year, Daisy Company began marketing a new beer called 'Serbesa'. To help promote the product, the management is offering a special Serbesa beer mug to each customer for every 20 specially marked bottle caps of Serbesa. The entity estimated that out of the 300, bottles of Serbesa sold during the year, only 50% of the marked bottle caps would be redeemed. During the year, the entity purchased 8,000 beer mugs at a total cost of P360,000 or P45 each and had already distributed 4, mugs to customers.
The estimated premium liability at year-end is P202,500.
Warranty Liability Estimation
Sam Company started business in 2015. It sells printers with a three-year warranty. Sam Company estimates its warranty cost as a percentage of peso sales. Based on past experience, it is estimated that 2% will be repaired during the first year of warranty, 4% will be repaired during the second year of warranty and 6% will be repaired in the third year. In 2015 and 2016, the
