Provisions and Other Current Liabilities

THEORETICAL
1. Which of the following describes a liability?
I. It is a present obligation of an entity arising from past transactions.
II. The settlement of a liability is expected to result in an outflow of resources embodying economic benefits.
a. I only c. Both I and II
b. II only d. Neither I nor II

2. Liabilities are
a. Any accounts having credit balances after closing entries are made
b. Obligations to transfer ownership shares to other entities in the future
c. Obligations arising from past transactions and payable in assets or services in the future
d. Deferred credits that are recognized and measured in conformity with generally accepted accounting
principles

3. Which one of the following items is not a liability?

a. Dividends payable in shares c. Advances from customers on contracts
b. Accrued estimated warranty cost d. Maturing portion of long-term debt

4. Which of the following should not be included in the current liabilities section of the balance sheet?
a. Deferred tax liability c. Trade accrued expenses
b. Trade notes payable d. Short-term non-interest-bearing notes payable

5. It is an event that creates a legal or constructive obligation because the entity has no other realistic alternative but
to settle the obligation
a. Events after the balance sheet date c. Adjusting event
b. Contingent event d. Obligating event

6. Magazine subscriptions collected in advance are treated as

a. Deferred revenue in the liability section
b. Deferred revenue in the shareholders’ equity section
c. A contra account to magazine subscriptions receivable
d. Magazine subscription refund in the income statement in the period collected

7. A retail store received cash and issued a gift certificate that is redeemable in merchandise. When the gift
certificate was issued,___________
a. Revenue account should be increased
b. revenue account should be decreased
c. Deferred revenue account should be increased
d. Deferred revenue account should be decreased

8. Liabilities which fail the recognition criteria and where the possibility of an outflow is remote should:
a. Be recognized as an accrual c. Be recognized as a contingent liability
b. Be recognized as a provision d. Not be recognized in the financial statement

9. Under PAS 37, provisions are recognized as liabilities if an entity has a present obligation that may be
a. Legal obligation only c. Either legal or constructive obligation
b. Constructive only d. Neither legal nor constructive obligation

10. PAS 37 requires a provision based on a range of possible outcomes to be measured based on:
a. Midpoint of the range c. Maximum of the range
b. Minimum of the range d. Best estimate of the expenditure

SITUATIONAL
1. To increase sales, Rabbi Company inaugurated a promotional campaign on June 30, 2015. Rabbi placed a
coupon redeemable for a premium in each box of cake sold at P200. A coffee mug costing P30 is offered as
premium to customers who send in 5 coupons and a remittance of P10. The distribution cost per premium is P5.
Rabbi estimated that only 80% of the coupons issued will be redeemed. For the six months ended December 31,
2015, the following is available:

Boxes of cake sold 20,000

Premiums purchased 3,000
Coupons redeemed 10,000

What is the estimated liability for coupons on December 31, 2015?

2. Rosa Company includes one coupon in each box of laundry soap it sells. A towel is offered as a premium to
customers who send in 10 coupons and a remittance of P20. Data for the premium offer are:
2015 2016
Boxes of soap sold 1,000,000 1,500,000
Number of towels purchased at P100 each 25,000 40,000
Coupons redeemed 200,000 350,000

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Provisions and Other Current Liabilities
The experience of Rosa Company indicates that only 30% of the coupons will be redeemed. How much is the
estimated liability for premiums on December 31, 2016?

3. During 2015, Lily Company introduced a new product carrying a two-year warranty against defects. The estimated
warranty costs related to peso sales are 4% within 12 months following sale and 6% in the second 12 months
following sale. Sales and actual warranty expenditures for the years ended December 31, 2015 and 2016 are as
follows:
Sales Actual expenditures
2015 5,000,000 150,000
2016 6,000,000 550,000

At December 31, 2016, what would be reported as estimated warranty liability?

4. Ella Company owns a car dealership that it uses for servicing cars under warranty. In preparing its financial
statements, the entity needs to ascertain the provision for warranty that it would be required to recognize at year-
end. The experience with warranty claims is as follows:

60% of all cars sold in a year have zero defect, 25% of all cars sold in a year have normal defect, and 15% of all
cars sold in a year have significant defect.

The cost of rectifying a “normal defect” in a car is P10,000. The cost of rectifying a “significant defect” in a car is
P30,000. The entity sold 500 cars during the year. What is the “expected value” of the provision for warranty for
the current year?

5. On November 25, 2015 an explosion occurred at a Magdalene Company plant causing extensive property
damage to area buildings. By March 1, 2016, claims had been asserted against Magdalene. Management and
counsel concluded that it is probable Magdalene will be responsible for damages and that P3,500,000 would be
responsible estimate of its liability. Magdalene’s P10,000,000 comprehensive public liability policy has a P500,000
deductible clause.
What should be reported in the December 31, 2015 financial statements which were issued on March 31, 2016?

6. The Top Bottling Corporation embarked on a promotional program whereby a key chain costing P15 each is given
away for every 10 bottle crowns returned plus P5. Top bottling Corporation estimates that only 40% of the bottle
crowns in the hands of consumers will be presented for redemption. The following information is available:
Quantity Amount
Bottles sold 1,000,000 P5,000,000
Key chains bought for giveaways 15,000 225,000
Key chains distributed to customers 10,000

Question 1: What amount of premium expense must be recognized in their year-end financial statements?

Question 2: What amount of premium liability must be recognized in their year-end financial statements?

7. During 2014, Vant Co. introduced a new line of machines that carry a three-year warranty against manufacturer’s
defects. Based on industry expense, warranty costs are estimated at 2% of sales in the year of sale, 4% in the
year after sale, 6% in the second year after sale. Sales and actual warranty expenditures for the first three-year
period were as follows:
Sales Actual Warranty Expenditures
2014 P600,000 P9,000
2015 1,500,000 45,000
2016 2,100,000 135,000
P4,200,000 P189,000

What amount should Vant report as a liability at December 31, 2016?

8. Warranty4U provides extended service contracts on electronic equipment sold through major retailers. The
standard contract is for three years. During the current year, Warranty4U provided 21,000 such warranty contracts
at an average price of P81 each. Related to these contracts, the company spent P200,000 servicing the contracts
during the current year and expects to spend P1,050,000 more in the future. What is the net profit that the
company will recognize in the current year related to these contracts?

9. Moon Company has recently launched a new model of consumer car. Its cars with a three-year warranty for
manufacturing defects. Past experience of similar models indicates that about 10% of the cars sold are with some
defects, of which 4% are minor defects, 3% are normal defects, 3% are major defects. For the year ended
December 31, 2015, the company sold 10,000 units of the new model. The following information relates to the
estimate of costs of defects associated with the new model:

Cost of repair/unit Probability Minor defects Normal defects Major defects

High 30% P 1,500 P 4,000 P 7,000
Medium 60% 1,200 3,000 5,000
Low 10% 1,000 1,500 2,000

What amount of provision should the company recognized for the year ended December 31, 2015?

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Provisions and Other Current Liabilities
10. A company offers a cash rebate of P1 on each P4 package of light bulbs sold during 2010. Historically, 10% of
customers mail in the rebate form. During 2015, 4,000,000 packages of light bulbs are sold, and 140,000 P1
rebates are mailed to customers. What is the rebate expense and liability, respectively, shown on the 2015
financial statements dated December 31?

11. Carmela Company is estimating a liability for claims in a legal dispute that is expected to be settled in a year’s
time. It estimated the following range of possible outcomes with their associated probabilities:
Range Estimated Outcome Probability
High P2,000,000 25%
Medium 1,200,000 35%
Low 600,000 40%

The current one-year treasury bills yield a return of 4%. An adjustment of 5% is considered appropriate for the risk
that the actual outcome will be different from the estimated outcome.

Question 1: What amount of provision should the company recognize assuming the risk adjustment in the
measurement of provision is by adjusting the discount rate used to discount the future outflows to the present
value?

Question 2: What amount of provision should the company recognize assuming the risk adjustment in the
measurement of provision is by calculating the expected present value of the future outflows and adding a risk
adjustment premium?

12. Daewoo Company is the main contractor engaged in the construction of a power plant of Marubeni Company. It
has now been determined that there are construction defects to the power plant. The best estimate for the costs
to rectify the defects is P100,000,000. It had previously recognized a provision for warranty of P40,000,000 on the
project as part of project costs. However, Daewoo Company believes it can recover a significant part of the costs
from the sub-contractors who performed some of the construction works. Negotiations with the sub-contractors
are still in progress and based on the latest estimate, only two sub-contractors have admitted liability. The amount
of recovery that is virtually certain is estimated at P10,000,000. What amount should be disclosed in the
statement of financial position to the provision?

Numbers 13 to 15 are based on the following information:

Vargas Company has 35 employees who work 8-hour days and are paid hourly. On January 1, 2014, the
company began a program of granting its employees 10 days of paid vacation each year. Vacation days earned in
2014 may first be taken on January 1, 2014. Information relative to these employees is as follows:
Hourly Vacation Days Earned Vacation Days Used
Year Wages by Each Employee by Each Employee
2014 P45.00 10 0
2015 46.00 10 8
2016 47.00 10 10

Vargas has chosen to accrue the liability for compensated absences at the current rates of pay in effect when the
compensated time is earned.

13. What is the amount of expense relative to compensated absences that should be reported on Vargas’ income
statement for 2015?

14. What is the amount of the accrued liability for compensated absences that should be reported in Vargas’
statement of financial position for the year ended December 31, 2015?

15. What is the amount of the accrued liability for compensated absences that should be reported in Vargas’
statement of financial position for the year ended December 31, 2016?

Strong people don’t put others down. They lift them up.

3 | FINANCIAL ACCOUNTING AND REPORTING II