CHAPTER 25

INTRODUCTION TO LIABILITIES

TOPIC OVERVIEW:
This chapter discusses liabilities, its characteristics, types and classification, initial
recognition, initial measurement, subsequent measurement, and reclassification,
derecognition and financial statement presentation.

LEARNING OBJECTIVES:
After studying this chapter, you should be able to:
1. Describe the elements in the definition of liabilities.
2. Identify the different categories and classifications of liabilities.
3. Describe the initial recognition, initial measurement, subsequent measurement,
reclassification, derecognition and financial statement presentation of liabilities.
4. Classify liability as current and non-current.
5. Compute the correct amount of liability and its related accounts.

LIABILITIES

Liabilities are present obligation of an entity arising from past transaction or events, the
settlement of which is expected to result in an outflow from the entity of resources
embodying economic benefits.

Elements in the definition of liability

1. Liability is a present obligation of an entity.
The entity liable should acknowledge its existing obligation to a particular payee,
whether the latter is identified or not.

An obligation is a duty or responsibility to act or perform in a certain way. This may

be legally enforceable as a consequence of a binding contract or statutory
requirement.

2. Liability arises from past transactions or events.

A transaction or event that will give rise to a liability should occur first prior to the
recognition of an item as liability.

The past event that gave rise to the present obligation is termed as obligating event.
An obligating event creates a legal or constructive obligation because the entity has
no realistic alternative but to settle the obligation.

Legal obligation vs. Constructive obligation

Legal Constructive
An obligation arising from An obligation that is derived from an entity’s action
a. Contract; where:
b. Legislation; or a. The entity indicated to other parties that it will
c. Other operations of law. accept certain responsibilities by reason of an
established pattern of past practice, published
policy, or a sufficiently current statement.
b. And as a result, the entity has created a valid
expectation on the part of the other parties that
it will discharge those responsibilities.

3. The settlement of liability requires an outflow of resources embodying economic

benefits.
 Settlement of a present obligation normally results in giving up resources embodying
economic benefits in order to satisfy the claim of the other party.

Settlement may occur in a number of ways, for example, by:

a. payment of cash;
b. transfer of other assets;
c. provision of services;
d. replacement of that obligation with another obligation; or
e. conversion of the obligation to equity.

However, an obligation may also be extinguished by other means, such as a creditor

waiving or forfeiting its rights.

Common accounts used to describe liabilities:

Accounts payable SSS Contributions payable
Notes payable PAG-Ibig Contributions payable
Loans payable PhilHealth Contributions payable
Bonds payable Withholding taxes payable
Mortgage payable Income taxes payable
Lease liability Utilities payable
Advances from customers Warranties payable
Unearned revenues Premiums payable
Deferred revenues Cash dividends payable
Unearned rent Property dividends payable
Salaries payable Constructive obligations
Accrued interest expense/Interest payable

INITIAL RECOGNITION OF LIABILITIES

A liability is recognized in the statement of financial position when

a. it is probable that an outflow of resources embodying economic benefits will result
from the settlement of a present obligation; and
b. the amount at which the settlement will take place can be measured reliably.

Under PFRS 9, financial liabilities are recognized on the Statement of Financial Position
when the entity becomes party to the contractual provisions of the instrument.

Financial vs. Non-financial liabilities

To appropriately assign peso amount to an item classified as liability, liability shall be
categorized as to either financial or non-financial liability.

A financial liability is any liability that is:

a. contractual obligation:
i. to deliver cash or another financial asset to another entity; or
ii. to exchange financial assets or financial liabilities with another entity under
conditions that are potentially unfavourable to the entity; or

b. a contract that will or may be settled in the entity’s own equity instruments and is:
i. a non-derivative for which the entity is or may be obliged to deliver a variable
number of the entity’s own equity instruments; or
ii. a derivative that will or may be settled other than by the exchange of a fixed
amount of cash or another financial asset for a fixed number of the entity’s own
equity instruments.

Other liabilities that did not meet the above requirements are non-financial liabilities.
Illustration: Financial vs. Non-financial liability
Required: Classify the following liabilities as to either financial/non-financial liability
Accounts payable SSS Contributions payable
Notes payable PAG-Ibig Contributions payable
Loans payable PhilHealth Contributions payable
Bonds payable Withholding taxes payable
Mortgage payable Income taxes payable
Lease liability Utilities payable
Advances from customers Warranties payable
Unearned revenues Premiums payable
Deferred revenues Cash dividends payable
Unearned rent Property dividends payable
Salaries payable Constructive obligations
Accrued interest expense/Interest payable

SOLUTION:

Financial Non-financial
 Accounts payable To be settled thru provision of service or delivery of non-
 Notes payable cash assets:
 Loans payable  Advances from customers
 Bonds payable  Unearned or deferred revenues
 Mortgage payable  Unearned rent
 Lease liability  Warranties payable
 Salaries payable  Premiums payable
 Accrued interest  Property dividends payable
expense/Interest payable
 Utilities payable Did not arise from a contract:
 Cash dividends payable  SSS Contributions payable
 PAG-Ibig Contributions payable
 PhilHealth Contributions payable
 Withholding taxes payable
 Income taxes payable
 Constructive obligations

Classification of Financial Liabilities

Financial liabilities are classified as

1) Financial liabilities at amortized cost

2) Financial liabilities at fair value through profit or loss
a) Designated financial liabilities at FVTPL
b) Held for trading
3) Financial liabilities that arise when a transfer of a financial asset does not qualify for
derecognition or when the continuing involvement approach applies
4) Financial guarantee contracts and commitments

Measurement of financial and non-financial liabilities

With available fair value
Initial measurement Subsequent measurement
Financial liabilities Either Either
 Fair value  Fair value
 Fair value minus  Amortized cost
transaction costs
 Non-financial Either Either
liabilities  Best estimate or amounts  Best estimate or amounts
needed to settle the needed to settle the
obligations, or obligations, or
 Measurement basis  Measurement basis
required by specific PFRS required by specific PFRS

Definition of relevant terms

Fair value
This is the price that would be received to sell an asset or paid to transfer a liability n an
orderly transaction between market participants at the measurement date. [PFRS 13]

Transaction costs
Transaction costs are incremental costs that are directly attributable to the acquisition,
issue or disposal of a financial liability. An incremental cost is one that would not have been
incurred if the entity had not acquired, issued or disposed of the financial liability.

Transaction costs include:

a. Fees and commissions paid to agents, advisers, brokers and dealers
b. Levies by regulatory agencies and securities exchanges
c. Transfer taxes and duties

Important notes:
For financial liabilities classified at fair value through profit or loss the following are made:
1. Measured at fair value;
2. Transaction costs are recognized as expense; and
3. Changes in fair values are recognized in profit or loss.

Non-availability of fair value for financial liabilities

For liabilities, in the absence of a quotation in a market, face amount and present value of
related cash flows may be used as basis in determining far value.

Short-term liabilities are normally measured at face amount.

On the other hand, long term liabilities shall be valued as follows:

Category Characteristics Measurement

Interest bearing Nominal interest rate is Face amount
liabilities not substantially different
with market rate

Nominal interest rate is Present value of

substantially different with principal and
market rate interest payments
---------------------------------------------------------------------------------------------------------------------

Non-interest Long-term liabilities Present value of

bearing (maturity of more than 12 principal payments
liabilities months)

Note: For problem solving purposes, if the problem indicates information that will enable
you to compute for present value of all payments, the appropriate initial measurement
would be its present value (short-term payables with no stated interest rates can be
measured at invoice amounts when the effect of discounting is immaterial.)

Illustration of Amortization of Liabilities

Below shows the components of amortization table to determine amortized cost using the
effective interest method.

Interest Carrying
Date Payment *Amortization
Expense value
(a) (b)
(c) (d) (e) (f) (g)

a. Issuance date
b. Initial measurement of the liability
c. Date of payment for interest, principal or both. For non-interest bearing note
payable on a lump sum basis, this column shall be represented by the subsequent
reporting date.
d. Amount of payment for interest or principal or both. For interest payment, the
amount is determined as follows:
(Outstanding face amount x Stated/Nominal/Coupon interest rate)
e. Amount of interest expense incurred. This shall be computed as follows: (Previous
carrying value x Effective/Market interest rate)
f. Determine by getting the difference between interest expense and payments made
during the period.
g. Carrying amount or the amortized cost

*Note: Amortization column shows the amount of adjustment to be made to the previously
reported carrying amount. This may represent amortization of premium or discount, or
portion of total payments applicable to principal.

RECLASSIFICATION OF LIABILITIES

PFRS 9, paragraph 4.4.2, states that an entity shall not classify a financial liability.

DERECOGNITION OF LIABILITIES

Financial liability is derecognized only when extinguished

a) the obligation specified in the contract is discharged, cancelled or it expires

b) an exchange between an existing borrower and lender of debt instruments with
substantially different terms or substantial modification of the terms of an existing
financial liability of part thereof.

Gain or loss on derecognition. The difference between the carrying amount of a financial
liability extinguished or transferred to a 3rd party and the consideration paid is
recognized in profit or loss.
FINANCIAL STATEMENT PRESENTATION

Classification of Liabilities for Financial Statement Presentation

\ Liabilities Current Liabilities A liability is classified as current if

a. it is expected to be settles within

the entity’s normal operating cycle.
b. it is expected to be settled within
12 months.
c. it is held for trading.
d. the entity has no unconditional
right to defer payment for at least
12 months from the reporting date.

Non-current Non-current liabilities are items

Liabilities
a. Other than current liabilities
b. Specifically required by a particular
standard to be classifies in this
category.

Examples of Current Liabilities

 Trade payables
 Accrual to employees and other
operating costs
 Customer’s credit balances
 Bank overdraft
 Dividends payable (except share
dividends)
 Income tax payable
 Current portion of long term financial
liabilities
 Accounts payable
 Short-term notes payable
 Liability under trust receipts
 Deposits and advances
 Deferred or unearned revenue
 Provisions expected to be settled
within twelve months
Chapter 25 - Introduction to Liabilities

Examples of Non-current Liabilities

 Non-current portion of long term debt

 Deferred revenue – non-current portion
 Finance lease liability
 Deferred tax liability
 Long-term obligations to company officers
 Long-term deferred revenue
 Long term notes payable
 Bonds payable
 Liability under finance leases not due within 12 months

Current Liabilities in the Statement of Financial Position

Under PAS 1, as minimum, the face of the Statement of Financial Position should include
the following line items for current liabilities:
a. Trade and other payables*
b. Current provisions
c. Short-term borrowing
d. Current portion of long-term debt
e. Current tax liability
*Line items for accounts payable, notes payable, accrued interest on note payable,
dividends payable and accrued expenses.

Additional items shall be presented on the face of the Statement of Financial Position when
such presentation is relevant to an understanding of the entity’s financial position.

Illustration: Classification of liabilities – current vs. non-current

Kobe Co. has the following liabilities as of December 31, 2016.
Trade accounts payable ₱ 600,000
Bonds payable 500,000
Trade notes payable 100,000
Security deposit 100,000
Cash dividends payable 80,000
Property dividends payable 75,000
Held for trading financial liabilities 60,000
Income tax payable 50,000
Advances from affiliates 50,000
Trade accounts payable granted to officers 30,000
Salaries and wages payable 25,000
SSS premiums payable 22,500
Deferred revenue 20,000
Unearned rent 15,000
Share dividend payable 15,000
Bank overdraft 10,000
Credit balance in customer’s accounts 8,000
Deferred tax liability 5,000
Accrued expenses 5,000
Chapter 25 - Introduction to Liabilities

Additional information:
 Deducted from trade accounts payable are
Debit balance n supplier’s account ₱20,000
Undelivered checks 16,000
Postdated checks 8,000
 Excluded from the trade accounts payable are
Goods received on consignment 18,000
Goods in transit, shipped FOB Shipping point 17,500
Goods in transit, shipped FOB Destination 15,500
 Bonds mature in five equal semi-annual instalments
 Security deposit was received from lessee. The amount will be refunded on December
31, 2021.
 The deferred tax liability arises from a temporary difference which will reverse in
2017.

Required: Determine the amount to be reported in the December 31, 2016 financial
statements as
a. Current liabilities
b. Non-current liabilities

SOLUTION:
a. The following items shall be presented as current liabilities:
Trade accounts payable – unadjusted ₱ 600,000
Add/(Deduct):
Debit balance in supplier’s account 20,000
Undelivered checks 16,000
Postdated checks 8,000
Goods in transit, shipped FOB
Shipping point 17,500
Trade accounts payable - adjusted ₱ 661,500
Bonds payable – current portion (500,000/5 x 2) 200,000
Trade accounts payable 100,000
Cash dividends payable 80,000
Property dividends payable 75,000
Held for trading financial liabilities 60,000
Income tax payable 50,000
Trade accounts payable granted to officers 30,000
Salaries and wages payable 25,000
SSS premiums payable 22,500
Deferred revenue 20,000
Unearned rent 15,000
Bank overdraft 10,000
Credit balance in customer’s accounts 8,000
Accrued expenses 5,000
₱ 1,362,000

b. The following items shall be presented as non-current liabities:

Bonds payable – noncurrent portion ₱ 300,000
Security deposit 100,000
Advances from affiliates 50,000
Deferred tax liability 5,000
Total non-current liabilities ₱ 455,000

The following item shall be presented as part of equity:

Share dividend payable ₱ 15,000
Chapter 25 - Introduction to Liabilities

Note: The deferred revenue is just like unearned revenue, it shall be presumed current
liability unless otherwise stated in the problem.

Classification of Long-Term Debt Falling Due Within One Year

The following rules shall be applied for long-term liabilities which are due to be settled
within twelve months from reporting dare.

Settlement and Refinancing

Original term of a To be settled on maturity date Current

period longer than
twelve (12) months
The debtor has the discretion to Noncurrent
refinance for a period of at least 12
months from the reporting date

To be refinanced AFTER the *Current

reporting date or for a period less
than 12 months from the
reporting date

To be refinanced ON OR BEFORE Noncurrent

the reporting date or for a period
less than 12 months from the
reporting date

Breach of provision of a loan arrangement

Presence of breach Required to be settled within 12 Current

of covenant/s months

A grace period was granted AFTER *Current

the reporting date or a period less
than 12 months from reporting
date

To be refinanced AFTER the Noncurrent

reporting date or for a period less
than 12 months from the
reporting date
Chapter 25 - Introduction to Liabilities

*Note: Quality for disclosure as non-adjusting events.

Illustration: Long-term debt falling due within one year

Rajon Co has the following liabilities on December 31, 2016:
8% Note payable ₱ 2,000,000
10% Note payable 1,500,000
11% Note payable 1,250,000
10% Note payable 1,000,000
12% Note payable 750,000
15% Note payable 500,000

Additional information:
1) The 8%, ₱2,000,000 Note payable is due on January 1, 2017 and is to be settled by
delivery of merchandise to the holder.
2) The 10%, ₱1,500,000 Note payable matures on June 30 and December 31. On
December 15, 2016, Rajon Co. entered into refinancing agreement with a bank to
refinance the note on a long-term basis. The refinancing and roll over transaction was
completed on December 31, 2016.
3) The 11%, ₱1,250,000 five-year Note payable was obtained by Rajon from a bank. The
agreement requires Rajon to maintain current ratio of 3:1. If the current ratio falls
below 3;1, the note becomes payable on demand. As of December 31, 2016, Rajon’s
current ratio is 1:5:1. On December 31, 2016, the bank agreed not to collect the note in
2017.
4) The 10%, ₱ 1,000,000 Loan Payable is payable on demand. However, on December 31,
2016, there is no indication that the payee on the loan will demand payment over the
next 12 months.
5) The 12%, ₱750,000 Loan payable is maturing on July 1, 2017. Interest on the loan is
due every July 1 and December 31. On January 15, 2017, Rajon Co, entered into a
refinancing agreement with a bank to refinance the loan on a long-term basis. Both
parties are financially capable of honouring the agreement’s provisions. Rajon has the
discretion to refinance or roll over the loan for at least twelve months from December
31, 2016 under an existing loan facility.
6) The 15%, Loan payable is due on June 30, 2017. Interest on the loan is payable every
June 30 and December 31. On December 15, 2016, Rajon and the creditor agree to
settle the obligation by giving the latter Rajon’s long-term investment in another
corporation.
Rondo’s financial statements were authorized for issue on March 15, 2017.

Required: Determine the amount of liabilities to be reported as current liabilities in the

statement of financial position.

SOLUTION:
The following items shall be presented as current liabilities:
8% Note payable (to be settled in 2017) ₱ 2,000,000
10% Loan payable (payable on demand) 1,000,000
15% Loan payable (to be settled in 2017) 500,000
Total current liabilities ₱ 3,500,000

The following items shall be presented as non-current liabilities:

10% Note payable (refinancing agreement
was completed on December 31, 2016) ₱ 1,500,000
11% Note payable (grace period was granted
On December 31, 2016) 1,250,000
Chapter 25 - Introduction to Liabilities

12% Loan payable (borrower’s discretion) 750,000

Total non-current liabilities ₱ 3,500,000

TRADE ACCOUNTS PAYABLE

Characteristic
Description Present obligations that are not supported by formal promises to pay
by the debtor. These obligations normally arise from acquisitions of
inventories to be used in the normal operating cycle of the entity.
Recognition When ownership of goods are transferred to the buyer.
Measurement Fair value, which is normally the invoice price of goods acquired and
may or may not be affected by related freight and cash discounts
Presentation Normally included in the current liabilities section under the heading
“Trade and other payable”

Initial Measurement
List or quoted price XX
Less: Trade discounts, rebates and other similar items XX
Initial measurement (gross method of recording purchases) XX
Less: Purchase discount XX
Initial measurement (net method of recording purchases,
whether discount is taken or not) XX

Pro-forma journal entries:

Gross Method Net Method
1) To record acquisitions of inventories:
Purchases xx Purchases xx
Accounts payable (gross) xx Accounts Payable (net) xx
2) To record payment made within the discount period:
Accounts payable (gross) xx Accounts payable (net) xx
Cash (net) xx Cash xx
Purchase discount xx
3) To record payment made beyond the discount period:
Accounts payable (gross) xx Accounts payable (net) xx
Cash (gross) xx Purchase discount lost xx
Cash (gross) xx
Effects of Freight Charges in Accounts Payable
Freight should Freight paid by: Effects on Accounts
be paid by: Payable
a. FOB Shipping point, Buyer Seller Additional payable
freight prepaid
b. FOB Shipping point, Buyer Buyer No effect
freight collect
c. FOB Destination, freight Seller Seller No effect
prepaid
d. FOB Destination, freight Seller Buyer Reduction in payable
collect

Illustration: Determination of Initial Measurement and Amount to Be Remited

On June 1, 2016, Angelica sold merchandise with a list price of ₱5,000,000 to Ash. Anglica
allowed trade discounts of 20% and 10%. Credit terms were 5/10, n/30 and the sale was
Chapter 25 - Introduction to Liabilities

made FOB shipping point. Angelica prepaid ₱200,000 of delivery cost for Ash as an
accommodation.

Required: Using the data above, answer the following:

1. What amount shall be recognized as Accounts Payable assuming Ash records
purchases under the following methods:
a. Gross method b. Net method
2. How much will be remitted by Ash to Angelica if payments are made under he
following independent situations:
a. June 11, 2016 b. June 16, 2016

SOLUTION:
1. Amount to recorded as part of accounts payable
List price ₱ 5,000,000
Less: Trade discount
[(₱5M x 20%) + (₱5M x 80% x 10%)] 1,400,000
Initial measurement under gross method –
this is also the invoice price of the merchandise
Less: Cash discount (₱3,600,000 x 5%) 180,000
Initial measurement under net method ₱3,420,000
The invoice price the merchandise may also be computed as follows:
(₱5M x (100%-20%) x (100% -10) = ₱3,600,000

2. Amount of remittance by Ash to Angelica:

June 11, 2016
List price ₱ 5,000,000
Less: Trade discount
[(₱5M x 20%) + (₱5M x 80% x 10%)] 1,400,000
Invoice price ₱ 3,600,000
Less: Cash discount (₱ 3,600,000 x 5%) 180,000
Balance ₱ 3,420,000
Add: Freight prepaid by the seller 200,000
Total amount due ₱ 3,620,000

June 16, 2016

List price ₱ 5,000,000
Less: Trade discount
[(₱5M x 20%) + (₱5M x 80% x 10%)] 1,400,000
Invoice price ₱ 3,600,000
Less: Cash discount (₱ 3,600,000 x 5%) -
Balance ₱ 3,600,000
Add: Freight prepaid by the seller 200,000
Total amount due ₱ 3,800,000

Illustration: Determination of Accounts payable balance

On December 31, 2016, Bryant Co. has accounts payable of ₱ 4,000,000 before possible
adjustment for the following:
a) Goods in transit from a vendor to Bryant on December 31, 2016 with an invoice cost of
₱ 200,000 purchased FOB shipping point was not yet recorded.
b) Goods shipped FOB shipping point from a vendor to Bryant was lost in transit. The
invoice cost of ₱80,000 was not yet recorded.
c) Goods shipped FOB shipping point from a vendor to Bryant on December 31, 2016
amounting to ₱32,000 was recorded and included in the year-end physical count as
“goods in transit.”
Chapter 25 - Introduction to Liabilities

d) Goods in transit from a vendor to Bryant on December 31, 2016 with an invoice cost of
₱ 40,000 purchased FOB destination was not yet recorded. The goods were received in
January 2017.
e) Goods with invoice cost of ₱ 60,000 was recorded and included in the year-end
physical count as “goods in transit.” It was found out that the goods were shipped from
a vendor under FOB destination.

Required:
Compute for the adjusted accounts payable on December 31, 2016.

SOLUTION:
Unadjusted balance ₱4,000,000
(a) Unrecorded purchases 200,000
(b) Unrecorded payable on purchases lost in transit 80,000
(e) Purchases that should be recorded in the next
Accounting period (60,000)
Total ₱4,220,000

Illustration: Determination of Accounts Payable Balance

On December 31, 2016, Michael Co. has accounts payable of ₱2,000,000 before possible
adjustment for the following:
a) Checks drawn but not yet released to payees amounted to ₱48,000 and post-dated
checks drawn and released to payees amounted to ₱20,000.
b) On December 28, 2016, a vendor authorized Michael to return for full credit goods
shipped and billed at ₱100,000 on December 31, 2016 but the credit memo was
receives and recorded only on January 3, 2017.
c) Goods shipped FOB shipping point, freight prepaid from a vendor on December 28,
2016 was recorded at invoice cost at shipment date. The invoice cost is ₱56,000 while
freight cost is ₱12,000.
d) Goods shipped FOB destination, freight collect were received on December 29, 2016.
The invoice cost of ₱160,000 was credited to accounts payable on date of receipt and
the relate freight of ₱20,000 was debited to an expense account.

Required:
Compute for the adjusted accounts payable on December 31, 2016.

SOLUTION:
Unadjusted balance – accounts payable ₱2,000,000
(a) Unreleased and postdated checks 68,000
(b) Purchase return (100,000)
(c) Unrecorded freight shouldered by seller 12,000
(d) Freight paid on behalf of the seller (20,000)
Total adjusted accounts payable ₱1,960,000

ESTIMATED LIABILITIES
Estimated liabilities are items that involve a present obligation and satisfy the rest if the
definition but can only be measured only by using a substantial degree of estimation.

BONUS PAYABLE
Bonus is a gratuity given by entities to their employees as a gift or compensation earned as
reward upon achieving a goal such as exceeding budgeted income during the year, meeting
quotas, and having a superior performance in a project or activity. The primary purpose of
this is to encourage performance from officers and employees by directly associating their
success to company’s success.

Pro-forma journal entry:

Chapter 25 - Introduction to Liabilities

Bonus expense xx
Bonus Payable xx

Bonus calculation
Bonus may be derived based from the following:
1. Net income before bonus and tax 4. Net income after tax but before
bonus
B = NY x BR B = BR x (NY – T)

2. Net income after bonus but before tax T = TR x (NY – B)

B = BR x (NY – B)
OR
OR
NY BR x [NY x (1 – TR)]
B = BR x B=
100% + BR 1 – BR + [BR x
(1-TR)]

3. Net income after bonus and tax Where:

NY = Net income before bonus and tax
B = BR x (NY – B – T) B = Bonus
BR = Bonus Rate
T = Tax
B = TR x (NY – B) TR = Tax Rate

OR

BR x [NY x (1 – TR)]
B=
1 + [BR x (1-TR)]

Illustration: Bonus Calculation

Riel, president of the CPA Co., has an arrangement with the company under which she
receives 10% bonus each year. For the current year, the net income before deducting even
the provision for income taxes or the bonus is ₱5,500,000. The bonus is deductible for tax
purposes and the tax rate is 30%.

Required: Determine the amount of Riel’s bonus and the appropriate provision for income
tax for the year under the following independent scenarios.
1) Bonus is calculated based on net income before bonus and income tax.
2) Bonus is calculated based on net income after bonus but before income tax.
3) Bonus is calculated based on net income after bonus and income tax.
4) Bonus is calculated based on net income after income tax but before bonus.

SOLUTION:
For (1) and (2) requirements:
To compute for the amount of bonus, it is imperative to compute for the basis of bonus.

To compute for the basis, we must first determine the equivalent percentage of the given
net income before bonus and income tax with the assumption that the basis has an
assigned value of “100%”. From there we can compute for the basis by dividing net income
before bonus and income tax with the percentile computed.
Chapter 25 - Introduction to Liabilities

To illustrate, let us compute for (1) and (2) requirements:

Requirement No. 1
 For requirement no. 1, NY before B and T is the basis. Thus, bonus can be simply
computed as follows:
Calculation of bonus
Bonus = NY before B and T x Bonus rate
Bonus = ₱5,500,000 x 10%
Bonus = ₱550,000

Requirement No. 2
 For requirement no. 2, bonus is calculated as follows:
Calculation of basis
NY before B and T (squeeze) 110%
Less: Bonus 10%
NY after B but before T 100%

NY after B but before T

(₱5,500,000/110%) ₱5,000,000

Calculation of bonus
Bonus = NY after B but before T x Bonus rate
Bonus = ₱5,000,000 x 10%
Bonus = ₱500,000

 For (1) and (2) requirements:

(1) (2)
NY before B and T ₱5,500,000 100% ₱5,500,000 110%
Less: Bonus 550,000 10% 500,000 10%
NY after B but before T ₱4,950,000 90% ₱5,000,000 100%
Less: Income tax (30%) 1,485,000 1,500,000
NY after B and T ₱3,465,000

Requirement No. 3
NY after B but before T (squeeze) = 100% / (1 – Tax rate)

Alternative Solution:

BR x [NY x (1 – TR)]
B=
1 + [BR x (1-TR)]

10% x [₱5,500,000 x (1 – 30%)]

B=
1 + [10% x (1-30%)]

₱ 385,000
B=
1.07

B= ₱359,813
Chapter 25 - Introduction to Liabilities

Requirement No. 4

 NY after B and T (squeeze) = 100% - 10% = 90%

 NY after B nut before T (squeeze) = 90% / (1 – Tax rate)

Alternative Solution:

BR x [NY x (1 – TR)]
B=
1 – BR + [BR x (1-TR)]

10% x [₱5.5M x (1 – 30%)]

B=
1 – 10% + [10% x (1-30%)]

₱ 385,000
B=
97%

B= ₱396,907

 For (3) and (4) requirements

(3) (4)
NY before B and T ₱5,500,000 153% ₱5,500,000 139%
Less: Bonus 359,813 10% 396,907 10%
NY after B but before T ₱5,140,187 143% ₱5,103,093 129%
Less: Income tax (30%) 1,542,056 43% 1,550,928 39%
NY after B and T ₱3,598,131 100% ₱3,572,165 90%
Add: Bonus 396,907 10%
NY before B but after T ₱3,969,072 100%

Summary of answers:
Bonus Tax
a. Net income before bonus and tax ₱550,000 ₱1,485,000
b. Net income after bonus but before tax ₱500,000 ₱1,500,000
c. Net income after bonus and tax ₱359,813 ₱1,542,056
d. Net income after tax but before bonus ₱396,907 ₱1,530,928

UNEARNED OR DEFERRED REVENUE

This represents income already collected but not yet earned. This item shall be presented
as part of entity’s liabilities and normally classified as current liabilities. Examples include
advances received from customers for goods yet to be delivered, services yet to be
provided, gift certificates sold, and subscriptions.

Pro-forma journal entries:

1. To record receipt of cash from advance orders:
Cash xx
Unearned revenue xx
Chapter 25 - Introduction to Liabilities

2. To record application of advances to service provided or orders shipped:

Unearned revenue xx
Sales or any appropriate account xx

Illustration: Unearned Revenue – Delivery of Goods

Jordan Co., requires advance payments for its products. The records of Jordan shoe the
following:

Unearned revenue, January 1, 2016 ₱ 500,000

Cash received form advances during 216 2,500,000
Advances applied to orders shipped in 2016 1,800,000
Advances applicable to orders cancelled in 2016 200,000

Required: Compute for the amount to be reported as unearned revenue assuming the
advance payments received are non-refundable.

SOLUTION:                    
      Unearned Revenue      
        ₱ 500,000   Balance, Beg.
Advances Applied to       Cash Received
shipments/Sale
s   ₱ 1,800,000 2,500,000   from advances
*Orders Cancelled 200,000        

      ₱ 3,000,000 ₱ 3,000,000      
Balance, End (squeezed) 1,000,000        

      ₱ 3,000,000 ₱ 3,000,000      

*Pro-forma entry to record advances applicable to orders cancelled

Unearned Revenue xx
Income from orders cancelled xx

Note: If the cash received in advance is refundable, the amount applicable to orders
cancelled is still presented as part of liabilities.

Illustration: Unearned Revenue – Provision of Services

Scottie Company sells office equipment service contracts aggreeing to service equipment
for a two-year period. Cash receipts from contracts are credited to unearrned service
contract and service contract costs are charged to service contract expense as incurred.
Revenue from service contracts is recognized as earned over the lives of the contracts.
Additional information for the year ended December 31, 2016 is as follows:

Unearned service contract at January 1 ₱ 200,000

Cash receipts from service contracts sold 440,000
Service contract revenue recognized 560,000
Service contract expense 280,000
Chapter 25 - Introduction to Liabilities

Required: Compute the amount to be reported as unearned service contract revenue at

December 31, 2016 by Scottie.

SOLUTION:                    
      Unearned service contract      
        ₱ 200,000   Balance, Beg.
                    Cash Receipts from
Service contract         service contracts
revenue recognized ₱ 560,000 440,000   sold  
      ₱ 560,000 ₱ 640,000      
Balance, End   80,000        
      ₱ 640,000 ₱ 640,000      

Illustration: Unearned Revenue – Gift Certificates

Pippen Co. has just opened a coffee shopand decided to sell gift certificates as part of its
marketing and promotional and promotional strategy. The validity period for these
certificates is six (6) months. Transactions relating to the gift certificates during the year
are shown below:

 Sold gift certificates worth ₱ 15,000.

 Gift certificates worth ₱ 9,000 were redeemed.
 ₱ 1,000 gift certificates expired.

Required: Compute for the amount of unearned revenue to be presented as current

liaibility related to these gift certificates sold.
XSOLUTION:                    
      Unearned service contract      
        -   Balance, Beg.  
Gift certificate                 Cash Receipts from  
redeemed   ₱ 9,000 ₱ 15,000   gifts certificate sold  
                       
Expired gift certificate ₱ 1,000            

      ₱ 10,000 ₱ 15,000      
Balance, End (squeezed) 5,000        

      ₱ 15,000 ₱ 15,000      

Illustration: Unearned Revenue – Subscriptions

Erwing Company sells sports magazine subscriptions of one to four year periods. Cash
receipts from subscribers are credited to the unearned revenue and this account had a
balance of ₱ 4,800,00 on December 31, 2016 before year-end adjustments. Outsatnding
subscription od December 31,2016expire as follows:

During 2017 ₱ 1,200,000 During 2019 ₱ 800,000

During 2018 1,000,000 During 2020 400,000

Required: Compute for the amount of unearned revenue to be reported as current liability
related to these magazine subscriptions on December 31, 2016.
Chapter 25 - Introduction to Liabilities

XSOLUTION:    
Current Liability:    
To expire in 2017   ₱ 1,200,000
       
Non-current Liability:
To expire in 2018   ₱ 1,000.000
To expire in 2019   800,000
To expire in 2020   400,000
Total Non-current   2,200,000

The difference of ₱ 1,400,000 (₱ 4,800,000 – ₱ 3,400,000) between the amount before

adjustment and total outstanding liability as of December 31, 2016, shall be recognized as
earned revenue.

DEPOSITS REVEIVED
Deposits received represent cash received and held in behalf of other entities such as
clients and customers. These items are recognized as liabilities and classified as to either
current or non-current depending on their settlement dates. Examples include deposit in
escrow accounts and refundable deposit on returnable containers.

Pro-forma journal entries:

1. To record receipt of cash from deposits:
Cash xx
Deposits (Liability account) xx

2. To record refunds of deposits

Deposits (Liability account) xx
Cash xx

Illustration: Escrow Deposits

On the first day of each month, Griffin company receives from a customer an escrow
deposit of ₱300,000 for value-added tax, Griffin records the ₱300,000 in an escrow liability
account. The customer’s value-added tax for the year is estimated at ₱3,500,000, payable in
equal installments on the 25 th day of each month. On January 1,2016, the balance of the
escrow account was ₱200,000.
Required: Determine the amount Griffin should show as escrow liability on behalf of this
customer on September 20, 2016.

 
SOLUTION:                  
      Escrow Liability  
        ₱ 200,000   Balance, Beg.
Cash payments nine       Cash receipt for
months     ₱ 2,625,000 2,700,000   Nine months
      ₱ 2,625,000 ₱ 2,900,000    
Balance, End
(squeezed) 275,000      
      ₱ 2,900,000 ₱ 2,900,000    

Illustration: Returnable Containers

Kevin Co. sells its products in reusable containers. The customer is charged a deposit when
containers are delivered and received a refund when containers are returned within one
year after the year of delivery. Deposits for containers not returned within the time limit
Chapter 25 - Introduction to Liabilities

are accounted as regarded as proceeds from sale of the containers. Information for 2016 is
as follows:

Container deposits at December 31, 2015, from deliveries in:

2014 ₱ 75,000
2015 90,000 ₱ 165,000

Deposits for containers delivered in 2016 140,000

Deposits for conyainers returned in 2016 from deliveries in:

2014 ₱ 50,000
2015 60,000
2016 70,000 180,000

Required: Determine the amount of liability for deposits on returnable containers on

December 31, 2016?

SOLUTION:                  
      Liability for Deposits    
        ₱ 165,000   Balance, Beg.
Cash refunds for          
container returned in       Cash deposits
2016     ₱ 180,000 140,000   from deliveries
*Proceeds from sale of        
containers   25,000      
      ₱ 205,000 ₱ 305,000    
Balance, End (squeezed) 100,000      
      ₱ 305,000 ₱ 305,000    

*This represents the balance from 2014 deliveries not returned as of December 31, 2016.
This is computed as follows:
(₱75,000 minus ₱25,000)

Such amount is treated as proceeds from sale of containers and not as liability.

Other Examples od Deposits Received and Their Corresponding Accounting

Treatment
1. Security deposits received from lessee aggreement
a. If the deposit is refundable, the amount shall be recognized as liability and its
classification as to either current or non-current will be dependent on its
settlementdate.
b. If the deposit is non-refundable, the amount as liability and will be recognized as
income over the term of the lease.
2. Deposits received from shareholders for future subscriptions
The deposit shall be presented as a line item in shareholder’s equity.

PROVISION AND CONTINGENT LIABILITY

A provision is a liability of uncertain amount or uncertain timing. Provisons are actually
estimated liability.

A provision is recognized when:

a. An entity has a present obligation (legal or constructive) as a result of a past event;
b. It is probable that an outflow of resources embodying economic benefits will be
required to the settlement of the obligation; and
c. A reliable estimate can be made of the the mount of the obligation.
Chapter 25 - Introduction to Liabilities

If these conditions are not met, no provision shall be recognized.

Pro-forma journal entry:

To record the recognition of a provision:
Expense XX
Estimated Liability XX

A contingent liability is:

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 uncertain future
events not wholly within the control of the entity, or
b. A present obligation that arises from past events but is not recognized because:
i. it is not probable that an outflow of resources embodying economic benefits will be
required to setle the obligation; or
ii. the amount of the obligation cannot be measured with sufficient reliability.

Relationship between provision and contingent liability

In general sense, all provisions are contingent because they are uncertain in timing or
amount. The term “contingent” is used for items that are not recognized because their
existence will be confirmed by occurence or non-occurrence of one or more uncertain
future events not within the control of the entity.

The “contingent liability” is used for liabilities that do not meet the recognition criteria.

Provision vs. contingent liability

Provision Contingent liability
 A present obligation  A possible obligation
 Both probable and reliably measurable  A present obligation which is either
 Recognized as a regular liability in the probable or reliably measurable but not
financial statements both
 Disclosed in the notes to financial
statements and not recognized in the
financial statements.

Likelihood of occurence Meaning

Probable The future event is more likely than not to occur. (i.e. the
probability that the event will occur is greater than the
possibility that it will not)
Reasonably possible The future event is less likely to occur.
Remote The future event is least likely to occur.

Summary of Accounting Treatments for Contingencies

Chapter 25 - Introduction to Liabilities

Level of Reliably Accounting Treatment

Remarks
Uncertainty Measurable Acrued Disclose Ignore
Loss
Contingencies

Probable Yes X Treated as Provision

Probable No X Categorized as
Possible Yes/No X contingent liabilities
Remote Yes/No X

Gain
Contingencies
Virtually
certain Yes X Treated as an asset
Virtually
certain No X Categorized as
Probable Yes/No X contingent assets
Possible/Remote Yes/No X
Basic rule: No contingent items shall be recognized on the face of the financial

Measurement of Provision
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. Best estimate is
determined as follows :
a) The estimates of outcome and financial effect are determined by the judgment of the
management of the entity, supplemented by experience of similar transactions and, in
some cases, reports from independent experts.
b) Where the provision being measured involveds a large population of items, the
obligation is estimated by weighting all possible outcomes by their associated
probabilities. The name for this statistical method of estimation is ‘expected value’.
c) Were there is continuos range of possible outcomes, and each point in that range is
as likey as any other, the mid-point of the range is used.

Consideration in determining best estimate

In reaching its best estimate, the entity should take into account the following:
1. Risk and uncertainties that surrounf the underlying events.

2. Future events
a. forecast reasonable changes in applying existing technology
b. ignore possible gains on sale of assets
c. consider changes in legislation only if virtually certain to be enacted

3. Discontinued present value using a pre-tax discount rate the reflects the current
market assessments of the time value money and the risks specific to the liability.
4. Reimbursement by another party
If some or all of the expenditure required to settle a provision is expected to be
reimbursed byanother party, the reimbursement should be recognized as a
separate assetprovided it is virtually certain that reimbursement will be received if the
entity settles the obligation.

The amount recognized as an asset shoulb not exceed the amount of the provision and
its should not be treated as a reduction of the required provision.
Chapter 25 - Introduction to Liabilities

5. Gains on expectedd disposal of assets

An entity recognizes gains on expected disposal of assets at the time of disposition of
assets.

6. Presence of onerous contract

If an entity has an onerous contract, the present obliation under the contract shall be
recognized and measured as a provision.

7. Reaeasurement of provisions
The following shall be performed when measuring provision subsequent initial
recognition
a. Review and anjust provision at each reporting date.
b. If an outflow no longer probable, provision is reversed.

8. Use of provisions
If it is no longer probable that an outflow of resources will be required to settle the
obligation, the provision should be reversed.

Examples of Provision
Circumstance Recognized a provision?
Restructuring by sale of Only when the entity is committed to a sale, i.e. there
an operation is a binding sale of agreement
Restructuring by closure Only when a detailed form plan is in place and the
or reorganization entity has started to implement the plan, or
announced its main features to those affected. A Board
decision is insufficient
Warranty When an obligating event occurs (sale of product with
a warranty and probable warranty claims will be
made)
Land contamination A provision is recognized as contamination occurs for
any legal obligations of clean up, or for constructive
obligations if the company’s published policy is to
clean up even if there is no legal requirement to do so
(past event is the contamination and public
expectation created by the company’s policy)
Customer refunds Recognize a provision if the entity’s established policy
is to give refunds (past event is the sale of the product
together with the customer’s expectation, at the time
of purchase, that a refund would be available)
Offshore oil rig must be Recognize a provision for removal costs arising from
removed and sea bed the construction of theoil rig as it is constructed, and
restored add to the cost of the asset. Obligations arising from
the production of oil are recognized as the production
occurs.
Abandoned leasehold, A provision is recognized for the unavoidable lease
four years to run, no payments.
reletting possible
Onerous (loss-making) Recognize a provision
contract
Self-insured restaurant, Accrue a provision (the past events is the injury to
people were poisoined, customers)
lawsuits are expected
but none has been filed
yet
A chian of retail stores is No provision until an actual fire (no past event)
Chapter 25 - Introduction to Liabilities

self-insured for fire loss.

CPA firm must staff No provision is recognized (there is no obligation to
training for recent provide the training, recognized a liability if and when
changes in tax law the retraining occurs)
Major overhaul or No provision is recognized (no obligation)
repairs
Future operating losses No provision is recognized (no obligation)

Illustration: Best estimate

Anthony Company sells cars. In 2016, the entity sold 1,000 units before discovering a
significant defect in their construction. By December 31, 2016, two lawsuits had been filed
against the entity. Below are the estimates made by the entity’s management and legal
counsel:
 First lawsuit – the entity has a little chance of winning and is expected to be settled out
of court for ₱2,500,000 in 2016.
 Second lawusit – The entity’s legal counsel believes that it is likely that the entity will
win. The entity is being sued for ₱1,000,000.

Required: Determine the amount of liability to be accrued on December 31, 2016 ass a
result of these lawsuits.

SOLUTION:
Liability to be accrued ₱2,500,000
 In the first lawsuit, since the entity is expecting to settle out of courts, the estimated
settlement shall be accrued in 2016.
 In the second lawsuit, since the level of uncertainty involved is only “likely”, which is
equivalent to possible, no liability shall be recognized but disclosure in the note to
financial statements shall be made.

Illustration: Best Estimate – Expected Value

Love Co. manufactures and sells motorcycle helmets. In 2016, the entity sold 1,000,000
units prior to the discovery of a possible defect vaused by malfunctioning factory
equipment. The helmets were recalled and will be repaired free of charge. Love is uncertain
whether all helmets recalled will have the possible defect. However, the following estimate
was made by Love’s management and was approved by the board of directors.

Repair Cost   Probability

₱40,000,000   10%
30,000,000   20%
20,000,000   30%
10,000,000   40%
    100%

Required: Determine the amount of liability to be accrued on December 31, 2016.

SOLUTION:
Repair
Cost   Probability Provision
₱40,000,00  
=
0 x 10% ₱ 4,000,000
 
=
30,000,000 x 20% 6,000,000
 
=
20,000,000 x 30% 6,000,000
Chapter 25 - Introduction to Liabilities

 
=
10,000,000 x 40% 4,000,000
₱20,000,00
    100%   0

Illustration: Best Esrimate – Mid-Point

In 2016, a lawsuit was filed against Kyrie Co. for patent infringement. The plaintiff is
claiming ₱5,000,000 in damages. Kyrie’s legal counsel believes that it is probable that Kyrie
will lose the lawsuit and pay damages of not less than ₱2,000,000 but not more than
₱10,000,000. The probability of any amount within the range is as likely as any other
amount also within the range.

Required: Determine the amount of liability to be accrued on December 21, 2016 as a

result of this lawsuit.

SOLUTION:
Liability to be accrued (₱2,000,000 + ₱10,000,000)/2 ₱6,000,000

Illustration: Provision – Changes in Estimate

In 2014, Stephen Co. recognized provision for a probable loss on pendinglawsuit of
₱10,000,000. The lawsuit remains unsettled in 2015 necessitating a reassessment of the
provision. Stephen determined that the probable loss on the pending law suit should be
₱14,000,000.

Required: Provide all necessary journal entries under the following independent
assumptions.
1) The lawsuit was settled for ₱15,000,000 in 2016.
2) The lawsuit was settled for₱12,750,000 in 2016.
3) Stephen won the lawsuit in 2016.

SOLUTION
Entry to be made in 2014:
Loss on lawsuit ₱10,000,000
Estimated liability ₱10,000,000

Entry to be made in 2015:

Loss on lawsuit 4,000,000
Estimated liability 4,000,000

1) The lawsuit was settled for ₱15,000,000 in 2016.

Estimated Liability 14,000,000
Loss on lawsuit 1,000,000
Cash 15,000,000

2) The lawsuit was settled for ₱12,750,000 in 2016.

Estimated Liability 14,000,000
Cash 12,750,000
Gain on settlement 1,250,000

3) Stephen won the lawsuit in 2016.

Estimated Liability 14,000,000
Gain on settlement 14,000,000
Note: Changes in estimate of provision are accounted prospectively.

ESTIMATED LIABILITIES – AFTER SALE TRANSACTION

Chapter 25 - Introduction to Liabilities

Liabilities may also arise after recognition of revenue from sale transactions. These
liabilities may include, but not limited to the following:
a. Premiums liability c. Warranties liability
b. Rebates liability

Premiums liability
Premiums are articles offered free or at a reduced price to make a combined offer more
attractive to the customers. In some cases, cash payments are also given to customers as a
result of past sales promotional activities.

Pro-forma journal entries:

1. To recognized provision for premiums to entitled customers:
Premium Expense XX
Premium liability (*net cost) XX
*Net cost is the excess of costs incurred in acquiring and distributing the premiums
inventory over any remittances received from customers.

2. To record acquisition of premiums inventory to be distributed:

Premiums inventory (cost) XX
Cash or Accounts payable XX

3. To record distribution of premiums to customers:

Premiums liability (net cost) XX
Cash (remittance received) XX
Premiums inventory (cost) XX

Illustration: Provision – Premiums

During 2016, Curry Company sold 100,000 boxes of cake mix under a new sales
promotional program. Each box contains one coupon. These coupons entitle the customers
to a baking pan upon remittances of ten coupons and ₱350. The entity pays ₱5000 per pan
and ₱25 for handling and shipping. The entity estimated that 80% of the coupons will be
redeemed even though only 50,000 coupons had been presented during 2016.
Required: Determine the amount of liability to be reported on December 31, 2016.

SOLUTION:                  
      Premiums liability    
        -   Balance, Beg.
Net cost of coupons                
redeemed   ₱ 875,000 1,400,000   Premiums expense
      ₱ 875,000 ₱ 1,400,000    
Balance, End   525,000      
      ₱ 1,400,000 ₱ 1,400,000    

1. The 100,000 coupons computed as follows:

100,000 boxes x 1
100,000 coupons = coupon
1 box

2. The net cost of coupons is computed as follows

  Cost per pan + handling and shipping
Net cost =
  - customer remittances
  ₱175   = ₱500 + ₱25 - ₱350
3. The premium expense sis computed as follows:
100,000 boxes x 80%
*Premium Expense = x ₱ 175
10 coupons
Chapter 25 - Introduction to Liabilities

4. The number of coupons redeemed is computed as follows:

50,000 boxes x 1 coupon
50,000 coupons =
1 box

5. Net cost of coupons redeemed

Net cost of 100,000 boxes x 80%
= x ₱ 175
coupons redeemed 10 coupons
      = ₱875,000    

Rebates liability
Pro-forma journal entries:
1. To recognized provision for rebates to entitled customers:
Rebates expense XX
Rebates liability XX

2. To record distribution of rebates to customers:

Rebates liability XX
Cash XX

Illustration: Provision – Rebates

Paul Company offers a cash rebate of ₱10 on each ₱500 of baking pan sold during 2016.
Customers must fill-up a rebate form and mail it to Paul. Paul will then mail to customers
the approved rebate form which can be used in future purchases to Paul. Based on entity’s
experience, only 20% of customers mail-in the rebate form.

During 2016, 500,000 packages of baking pans are sold and 85,000 rebates form where
mailed to customers.

Required: Determine the amount of liability to be reported on December 31, 2016.

SOLUTION:                  
      Rebates liability    
Balance,
        -   Beg.
Rebates form         Rebates
mailed**     850,000 1,000,000   expense*
      ₱ 850,000 ₱ 1,000,000    
Balance, End   150,000      
      ₱ 1,000,000 ₱ 1,000,000    

1. The 500,000 forms are computed as follows:

5000,000 packages x 1 form
500,000 forms =
1 pack

2. The expense is computed as follows:

5000,000 forms x 20%
Rebates expense = x ₱ 10
1 form

3. The rebates is computed as follows:

85,000 forms
Rebates redeemed = x ₱ 10
1 form
    = ₱850,000    
WARRANT LIABILITY
Warranty is legally binding assurance that a product is, among other things
Chapter 25 - Introduction to Liabilities

 Fit for use as presented

 Free form defective material and workmanship
 Meets statutory and/or other specifications.

A warranty describes the conditions under, and period during, which the producer or
vendor will repair, replace, or other compensate for, the defective item without cost to the
buyer or user. Often, it also delineates the rights and obligations of both parties in case of a
claim or dispute.

Warranty is recorded at the time of sale based on best estimate. Estimate is reviewed at a
certain date and difference between estimate and actual cost is accounted as change in
accounting estimate to be treated as currently and prospectively.

Pro-forma journal entries for transactions involving warranty under accrual approach
a. When products with warranties are sold
Warranties expense XX
Estimated warranties liability XX

b. Disbursement for warranty

Estimated warranties liability XX
Cash XX
c. Actual cost exceeds estimate
Warranties expense XX
Cash XX
d. Actual cost is less than estimate
Estimated warranties liability XX
Warranties expense XX

Illustration: Provision – Warranties

George Company sells motorcycles that carry a two-year warranty against manufacturer’s
defects. Based on entity’s experience, warranty costs are estimated at ₱5,000 per unit.
During the current year, the entity sold 1,000 units and paid warranty costs of
₱3,3400,000.
Required: Determine the amount of liability to be reported.

SOLUTION:                  
      Warranties liability    
        -   Balance, Beg.
Cost incurred for         *Warranties
warranties   ₱ 3,400,000 5,000,000   expense
      ₱ 3,400,000 ₱ 5,000,000    
Balance, End   1,600,000      
      ₱ 5,000,000 ₱ 5,000,000    
*(₱5,000 x 1,000 units)

Illustration: Warranty – Sales are Made Evenly

Carmelo Co. sells computer to various customers. Carmelo Co. has been offering a special
service warranty on computer units it sold. With the purchase of the computer unit, the
customer has the right to purchase 3-year service contract for additional amount of ₱1,000.
Data concerning sales of computer and warranty contract follow:

          2015 2016
Computer sales in units     1,000 1,200
Chapter 25 - Introduction to Liabilities

Sales price per unit       ₱12,000 ₱14,000

Number of service contracts sold   800 900
Expenses relating to computer warranties   ₱30,000 ₱50,000

Carmelo Co. has estimated based on the available past records that the pattern of repairs
has been:
44% Year of sale
38% 1st year of sale
18% 2nd year of sale

Sales of the contracts are made evenly during the year.

Required:
1) How much unearned service contract would be recognized in year 2016?
2) How much profit on service contract would be recognized in year 2016?
3) How much is unearned service contract on December 31, 2016?
4)
SOLUTION:            
Pattern of Realized Revenues:        
2015 SALES            
From sales in:   2015 2016 2017 2018 Total
st
1 (44% x 1/2)   0.22 0.22     0.44
nd
2 (38% x 1/2)     0.19 0.19   0.38
3rd (18% x 1/2)       0.09 0.09 0.18
Total     0.22 0.41 0.28 0.09 1
             
2016 SALES            
From sales in:   2015 2016 2017 2018 Total
st
1 (44% x 1/2)   0.22 0.22     0.44
2nd (38% x 1/2)     0.19 0.19   0.38
rd
3 (18% x 1/2)       0.09 0.09 0.18
Total     0.22 0.41 0.28 0.09 1

Requirement No. 1  
Warranty Sales in 2015 earned in 2016 (41% x 800 x ₱1,000) 328,000
Warranty Sales in 2016 earned in 2016 (38% x 900 x ₱1,000) 198,000
Total warranty sales revenue earned in 2016 526,000

Notes:
 The 41% represents the realized revenue in 2016 from 2015 sales.
 The 22% represents the realized revenue in 2016 from 2016 sales.

Requirement No. 2  
Total warranty sales revenue earned in 2016 (see no. 1) ₱526,000
Expenses relating to computer warranties 50,000
Profit from sales warranty 476,000
               
Requirement No. 3  
Unearned sales warranty from 2015 [(28% + 9% x 800 x ₱1,000)] ₱526,000
Unearned sales warranty from 2016 [(100%-22%) x 900 x ₱1,000)] 50,000
Profit from sales warranty 476,000

Notes:
 The 28% and 9% represent the unrealized revenues in 2016 from 2015 sales.
Chapter 25 - Introduction to Liabilities

 The 22% represents the realized revenue in 2016 from 2016 sales. So 100% minus 22%
realized is equal to 78% unrealized revenue in 2016 from 2016 sales.

CHAPTER 25: REVIEW QUESTIONS - COMPUTATIONAL

Chapter 25 - Introduction to Liabilities

PROBLEM 25-1 Total Liabilities

Harden Company reported the following information on December 31, 2016:

Bonds payable ₱ 5,000,000

Discount on bonds payable 500,000
Loan payable, with ₱500,000 payable
semi-annually starting 06/30/2017 2,500,000
Accounts payable 1,000,000
Unearned rent income 300,000
Income tax payable 250,000
Cash dividend payable 100,000
Cash surrender value of officers’ life insurance 75,000
Patent 50,000
Advances to employees 45,000
Deferred tax liability 15,000
Loan on James guaranteed by Harden (It is possible that James 500,000
will be held liable for the guarantee)
Share dividends payable 150,000
Bank overdraft – part of cash management 10,000

Total liabilities to be reported in the company’s December 31, 2016 statement of financial
position is:
a. ₱8,835,000 c. ₱7,545,000
b. ₱8,665,000 d. ₱7,325,000

PROBLEM 25-2 Current Liabilities

An analysis of Howard Company’s liabilities on December 31, 2016 disclosed the following
information:

Accounts payable, after deducting debit balances in suppliers’ accounts

amounting to ₱100,000 and postdated checks of ₱50,000 ₱4,000,000
Bonds Payable 1,000,000
Premium on bonds payable 100,000
Mortgage payable 850,000
Share dividends payable 750,000
Credit balances in customers’ accounts 500,000
Premiums payable 600,000
Deferred tax liability 200,000
Deferred revenue 175,000
Accrued expenses 100,000

The deferred tax liability is based on temporary differences that will reverse in 2017.

Total amount of current liabilities in the statement of financial position is:

a. ₱5,400,000 c. ₱5,775,000
b. ₱5,575,000 d. ₱7,375,000

PROBLEM 25-3 Refinancing

Included in Dwight Company’s liability balances on December 31, 2016 are:
10% note payable, maturing 03/31/2017 ₱ 10,000,000
12% note payable, maturing 06/30/2017 6,000,000
7% guaranteed debentures, due 2020 2,000,000

Additional information:
Chapter 25 - Introduction to Liabilities

 On January 31, 2017, the entire ₱10,000,000 note was refinanced through issuance of a
long-term obligation payable lump sum.
 For the ₱6,000,000 note, under the loan agreement, the entity has the discretion to
refinance the obligation for at least 12 months after December 31, 2016.
 The annual sinking fund requirement on the guaranteed debentures is ₱500,000 per
year.
 The 2016 financial statements were issued on March 31, 2107.

Assuming all accruing interest for 2106 were paid, the amount to be reported as current
liabilities on December 31, 2016 is
a. ₱19,300,000 c. ₱10,500,000
b. ₱16,500,000 d. ₱6,500,000

PROBLEM 25-4 Refinancing

Tim Co. has a 10%, ₱2,000,000 loan payable as of December 31, 2016 that is maturing on
July 1, 2017. Interest on the loan is due every July 1 and December 31. On February 1, 2017,
Tim Co. entered into a refinancing agreement with a bank to refinance the load on a long-
term basis. Both parties are financially capable of honoring the agreement’s provision.
Tim’s financial statements were authorized for issue on March 15, 2017.

How much is presented as current liability in relation to the loan in Tim’s 2016 year-end
financial statements?
a. ₱2,000,000 c. ₱100,000
b. ₱200,000 d. Nil

PROBLEM 25-6 Accounts payable

Duncan Company’s accounts payable balance at December 31, 2016 was ₱8,000,000 before
considering the following data:
 Goods shipped to Duncan FOB shipping point on December 15, 2016 were lost in
transit. The invoice cost of ₱500,000 was not recorded by Duncan. On January 15, 2017,
Duncan filed a ₱500,000 claim against the common carrier.
 On December 30, 2016, a vendor authorized Duncan to return for full credit goods
shipped and billed at ₱200,000 on December 15, 2016. The returned goods were
shipped by Duncan on December 31, 2016. A ₱200,000 credit memo was received and
recorded on January 5, 2017.
What should Duncan report as accounts payable on December 31, 2016?
a. ₱8,500,000 c. ₱7,800,000
b. ₱8,300,000 d. ₱7,500,000

PROBLEM 25-7 Accounts payable

Ray Company began operations late in 2015. For the first quarter ended March 31, 2106,
Ray made available the following information:

Total merchandise purchased through March 15, recorded at net ₱4,900,000

Merchandise inventory at December 31, 2015 at selling price 1,500,000

All merchandise was acquired on credit and no payments have been made on accounts
payable since the inception of the company. All merchandise is marked to sell at 50% above
invoice cost before time discounts of 2/10, n/30. No sales were made in 2016. How much
cash is required to eliminate the current balance in accounts payable?
a. ₱6,400,000 c. ₱5,900,000
b. ₱6,000,000 d. ₱5,750,000

PROBLEM 25-8 Bonus payable

Chapter 25 - Introduction to Liabilities

Tony Co. provides an incentive compensation plan under which its chief executive officer
receives a bonus equal to 10% of the company’s income in excess of ₱800,000 before bonus
and income tax. If income before bonus and income tax for 2016 amounted to ₱2,200,000
and income tax is 30%, the amount of bonus would be
a. ₱220,000 c. ₱132,000
b. ₱200,000 d. ₱120,000

PROBLEM 25-9 Bonus payable

After three profitable years, Parker Company decided to offer a bonus to its branch
manager at 25% of income for the branch was ₱1,000,000 earned by the branch during the
current year. The income for the branch was ₱1,600,000 before tax and before bonus for
the current year. The bonus is computed on income in excess of ₱1,000,000 after deducting
the bonus but before income tax. The bonus for the current year is:
a. ₱320,000 c. ₱150,000
b. ₱250,000 d. ₱120,000

PROBLEM 25-10 Unearned Revenue

Ginobili Company sells gift certificates redeemable only when merchandise is purchased.
The certificates have an expiration date two years after the issuance date. Upon
redemption or expiration, Ginobili recognizes the unearned revenue as realized. Data for
2016 are as follows:

Unearned revenue, 1/1 ₱ 1,500,000

Gift certificates sold 5,000,000
Gift certificates redeemed 4,000,000
Expired Gift certificates 300,000
Cost of goods sold 60%

At December 31, 2016, Ginobili Company should report unearned revenue at

a. ₱2,500,000 c. ₱1,000,000
b. ₱2,200,000 d. Nil

PROBLEM 25-11 Advances from Customers

Manu Company requires advances payments with special order for machinery constructed
to customer specifications. These advances are nonrefundable.
Information for the current year is:

Advances from customers, 1/1 ₱ 1,100,000

Advances received with orders 1,800,000
Advances applied to orders shipped 1,600,000
Advances applicable to orders cancelled 100,000

In Manu’s December 31 balance sheet, what amount should be reported as current liability
for advances from customers?
a. ₱1,400,000 c. ₱1,200,000
b. ₱1,300,000 d. Nil

PROBLEMS 25-12 Escrow Liability

On the first day of each month, Pierce Company receives from a customer an escrow
deposit of ₱500,000 for estate tax. Pierce records the ₱500,000, payable in an escrow
account. The customer’s real estate tax is ₱5,600,000, payable in equal installments on the
first day of each calendar quarter. On January 1, 0216, the balance of the escrow account
was ₱600,000. On September 30, 2016, what amount should Pierce show as escrow liability
in behalf this customer?

a. ₱2,300,000 b. ₱1,700,000
Chapter 25 - Introduction to Liabilities

c. ₱900,000 d. ₱300,000

PROBLEM 25-13 Container’s Deposits

Garnett Co. requires deposits from customers for the containers of goods sold. The
customers are refunded for the deposits received when the containers are returned within
two years from the date of sale on the related goods. Deposits for containers not returned
within the time limit are regarded as proceeds from retirement of the containers.
Information is as follows:

Containers deposits at December 31, 2015, from delivers in:

2014 ₱ 10,000
2015 90,000 ₱100,000

Deposits for containers delivered in 2016 100,000

Deposits for containers returned in 2016 from deliveries in:

2014 ₱ 10,000
2015 40,000
2016 42,000 92,000

How much is the liability for deposits on returnable containers on December 31, 2016?
a. ₱118,000 c. ₱108,000
b. ₱115,000 d. ₱100,000

PROBLEM 25-14 VAT payable

Kevin Company operates a retail store. All items are sold subject to a 12% value added tax
which the entity collects and records as sales revenue. The entity files quarterly sales tax
returns when due by the 20th day following the end of the sales quarter. However, in
accordance with state requirements, the entity remits value added tax collected by the 20th
day of the month following any month if such collections exceed ₱100,000. The entity takes
these payments as credits on the quarterly sales tax return. The value added taxes paid are
charged against sales revenue. Following is a monthly summary appearing in the first
quarter of 2016 sales revenue account:

Debit Credit
October - ₱ 1,120,000
November 120,000 784,000
December - 896,000

On December 31, 2016, the amount to be reported as valued added tax payable is:
a. ₱180,000 c. ₱300,000
b. ₱216,000 d. ₱336,000

PROBLEM 25-15 Provision: Continuous range of outcome

On November 5, 2016, a Sheradex Company truck was in an accident with an auto driven
by Joy. Sheradez received notice on January 15, 2017, of a lawsuit for ₱4,000,000 damages
for personal injuries suffered by Joy. Sheradez’s counsel believes it is probable that Joy will
be awarded an estimated amount in the range between ₱10,000 and ₱4,000,000, and no
amount is better estimate of potential liability than any other amount. The accounting year
ends on December 31 and the 2016 financial statements were issued on March 31, 2017.
What amount of provision should sheradez accrue at December 31, 2016?
a. ₱4,000,000 c. ₱2,005,000
b. ₱10,000 d. Nil

PROBLEM 25-16 Provision: Expected value with adjustment factor

Chapter 25 - Introduction to Liabilities

An entity is the defendant in a patent infringement lawsuit. The entity’s lawyers believe
there is a 30 percent chance that the court will dismiss the case and the entity will incur no
outflow of economic benefits. However, if the court rules in favor of the claimant, the
lawyers believe that there is a 20 percent chance that the entity will be required to pay
damages of ₱200,000 (the amount sought by the claimant) and an 80 percent chance that
the entity will be required to pay damages of ₱100,000 (the amount that was recently
awarded by the same judge in a similar case). Other outcomes are unlikely that the
claimant will settle out of court.

A 7 percent risk adjustment factor to the probability-weighted expected cash flows is

considered appropriate to reflect the uncertainties in the cash flow estimates. An
appropriate discount rate is 10 percent per year. At December 31, 2016 the entity
recognizes a provision for the lawsuit measured at:
a. Nil c. ₱100,000
b. ₱89,880 d. ₱81,709

PROBLEM 25-17 Restructuring Provisions

Axe Company’s directors decided on November 1, 2016 to restructure the entity’s
operations as follows:
 Factory A would be closed down and put on the market for sale.
 Employees working in factory A would be retrenched on November 30, 2016, and
would be paid their accumulated entitlements plus six months’ wages.
 Some employees working in Factory A would be transferred to Factory B, which would
continue operating.
 On December 31, 2016, the following transactions and events had occurred:
o The retrenched employees have left and their accumulated entitlements have been
paid. However, an amount of ₱1,000,000, representing a portion of the six months’
wages for the retrenched employees, has still not been paid.
o Costs of ₱300,000 are expected to be incurred in transferring the remaining
employees to their new work in Factory B. The transfer is planned for January 5,
2017.
o One employee, Crystal Maiden, remains in order to complete administrative tasks
relating to the closure of Factory A and the transfer of employees to Factory B.
Crystal Maiden expected to stay until January 31, 2017. Her salary for January will
be ₱50,000 and her retrenchment package will be ₱150,000, all of which will be paid
on the days she leaves. Crystal Maiden would spend 60% of her time administering
the closure of Factory A, 30% on administering the transfer of employees to Factory
B, and the remaining 10% on general administration.
What total amount should be recognized as restructuring provision on December 31, 2016?
a. ₱1,480,000 c. ₱1,500,000
b. ₱1,200,000 d. ₱1,180,000

PROBLEM 25-18 Contingencies

In September 2016, the lawyers of the current and former employee of Fisher Inc. filed a
₱3,000,000 class action lawsuit, alleging that exposure to radiation have caused significant
medical problems. The lawyer of Fisher is uncertain as to the outcome of the case.
However, similar lawsuits against other firms in the same industry have resulted in
significant payments by the employer but there was no reliable estimate as to the amount.

In Fisher’s December 31, 2016 financial statements, which were issued on April 30, 2017,
how much should item be reported?
a. An accrual of ₱3,000,000
b. No disclosure or accrual is necessary
c. A disclosure indicating a possible loss of ₱3,000,000
Chapter 25 - Introduction to Liabilities

d. If the payment can be estimated, a liability should be recognized, but if the amount
of expected payment cannot be estimated, only a note disclosure would be required.

PROBLEM 25-19 Contingencies

In January 2016, Derick Co. gives a guarantee on a loan of Rose Corp. amounting to
₱3,000,000. During the year, the financial condition of the rose deteriorates and at year-
end, Rose files a petition for bankruptcy. In its year-end financial statements, Derick should
a. Not accrue and need not disclose the guarantee
b. Accrue and disclose the provision of ₱3,000,000
c. Accrue a provision for liability of ₱3,000,000
d. Disclose the possible loss of ₱3,000,000

PROBLEM 25-20 Premiums Payable

To increase sales, Nowitzki Company inaugurated a promotional campaign on June 30,
2016. Nowitzki placed a coupon redeemable for a premium in each box of cake sold at
₱200. A coffee mug costing ₱30 is offered as premium to customers who send in 5 coupons
and a remittance of ₱10. The distribution cost per premium is ₱5. Nowitzki estimated that
only 80% of the coupons issued will be redeemed. For the six months ended December 31,
2016, 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, 2016?

a. ₱90,000 c. ₱75,000
b. ₱80,000 d. ₱30,000

PROBLEM 25-21 Premiums

Pacquiao Company includes one coupon in each package of cereal it sells. A towel is offered
as a premium to customers who send in 10 coupons. Data for the premium offer are:

2015 2016
Packages or cereal sold 500,000 800,000
No. of towels purchased at ₱40 per towel 30,000 60,000
No. of towels distribtued as premium 20,000 50,000
No. of towels to be distributed as premium next period 5,000 3,000

In its 2016 income statement, Pacquiao Company should be report premium expense at
a. ₱2,400,000 c. ₱2,000,000
b. ₱2,120,000 d. ₱1,920,000

PROBLEM 25-22 Warranty Liability

During 2015, Dirk Company introduced a new product carrying a two-year warranty
against defects. The estimated warranty cost 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 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?

a. ₱400,000 c. ₱240,000
b. ₱360,000 d. ₱50,000
Chapter 25 - Introduction to Liabilities

PROBLEM 25-23 Warranty Liability

On April 1, 2016, Carter Company began offering a new product for sale under a one-year
warranty. Of the 5,000 units in inventory at April 1, 2016, 3,000 had been sold by June 30,
2016. Based on its experience with similar products, the entity estimated that the average
warranty cost per unit sold would be ₱160. Actual warranty costs incurred from April 1
through June 30, 2016 were ₱140,000.

On June 30, 2016, the amount to be reported as warranty liability is?

a. ₱180,000 c. ₱340,000
b. ₱240,000 d. ₱660,000

PROBLEMS 25-24 Warranty- Sales are Made Evenly

Vince Co. sells computer to various customers. Vince Co. has been offering a special service
warranty on computer units it sold. With the purchase of the computer unit, the customer
has the right to purchase 3-year service contract for additional amount of P1,500. Data
concerning sales computer and warranty contract are as follows:
2015 2016
Computer units sold 2,500 2,800
Sales price per unit 14,000 14,000
Number of service contracts sold 1,000 1,200
Expenses relating to computer warranties 45,000 60,000

Vince Co. has estimated based on the available past records that the pattern of repair has
been:

40% Year of sale

36% 1st year after sale
24% 2nd year after sale

Sales of the contract are made evenly during the year.

Questions:
Based on the above data, answer the following:
1. How much unearned service contract would be recognized in year 2016?
a. P930,000 c. P1,200,000
b. P1,440,000 d. P2,070,000

2. How much profit on service contract would be recognized in year 2016?

a. P930,000 c. P570,000
b. P870,000 d. P360,000

3. How much is unearned service contract on December 31, 2016?

a. P2,070,000 c. P1,440,000
b. P630,000 d. P930,000
Chapter 25 - Introduction to Liabilities

COMPREHENSIVE PROBLEM

PROBLEM 25-55 Refinancing

On December 31, 2016, McGrady Co. has a 12%, P2,000,000, loan payable due on June 30,
2017. Interest on the loan is due every December 31. The financial statements were
authorized for issue on March 1, 2017. How much is presented as current liability in
relation to the loan on December 31, 2016 statement on financial position?

Questions:
1. Assume that no other data are presented.
a. Nil c. P40,000
b. P2,000,000 d. P2,040,000

2. Assuming both parties are financially capable of honouring the agreement’s provisions
and McGrady Co. has the discretion to refinance or roll over the loan for at least twelve
months from December 31, 2016.
a. Nil c. P40,000
b. P2,000,000 d. P2,040,000

3. Assume that on December 15, 2016. McGrady Co. entered into a refinancing agreement
with a bank to refinance the loan on a long-term basis. The refinancing agreement was
completed on December 31, 2016.
a. Nil c. P40,000
b. P2,000,000 d. P2,040,000

4. Assume that on January 5, 2017, McGrady Co. entered into a refinancing agreement with
a bank to refinance the loan on a long-term basis. The refinancing agreement was
completed on January 31, 2017.
a. Nil c. P40,000
b. P2,000,000 d. P2,040,000

PROBLEM 25-56 Obligations payable on Demand, Breach of loan Agreement

On December 31, 2016 Tracy Co. has a 12%, P2,000,000 loan payable due on June 30, 2024.
Interest on the loan is due every December 31. The financial statements were authorized
for issue on March 1, 2017. How much is presented as current liability in relation to the
loan on December 31, 2016 statement of financial position?

Questions:
Based on the above data, answer the following.
1. Assume that the loan is payable on demand although on December 31, 2016, there is no
indication that the payee on the note will demand payment over the next 12 months.
a. Nil c. P40,000
b. P2,000,000 d. P2,040,000

2. Assume instead that the loan agreement requires Tracy to maintain a current ratio 3:1. If
the current ratio falls this amount, the loan becomes payable on demand. As of December
31, 2016, Tracy’s current ratio is 2:5:1. On December 31, 2016, the creditor agreed not to
collect the loan in 2017 and gave Tracy 12 months to rectify the breach of loan agreement.
a. Nil c. P40,000
Chapter 25 - Introduction to Liabilities

b. P2,000,000 d. P2,040,000

3. Assume instead that the loan agreement requires Tracy to maintain a current ratio 3:1. If
the current ratio falls this amount, the loan becomes payable on demand. As of December
31, 2016, Tracy’s current ratio is 2:5:1. On January 6, 2017, the creditor agreed not to
collect the loan in 2017 and gave Tracy 12 months to rectify the breach of loan agreement.
a. Nil c. P40,000
b. P2,000,000 d. P2,040,000

PROBLEM 25-27Contingencies
Dwayne Company, a manufacturer of Viagra has had a lawsuit filed against in the Vic
Incorporated, another manufacturer of Viagra. The suit alleges patent that infringements
by Dwayne Company and asks for compensatory damages.
For the following likely situations, determine how Dwayne Company should report the
information concerning the lawsuit. The choices are:
a. Accrue and disclose
b. Disclose only
c. Accrue only
d. Neither accrue nor disclose

Assume the following independent cases:

1. Dwayne Company’s legal counsel is convinced that the likelihood of losing the case is
probable, the potential amount of the loss is estimated to be P2,300,000.

2. Dwayne Company’s legal counsel estimates that the infringement case may result in a
loss of P2,000,000 but considers the likelihood of losing the case as remote.

3. Dwayne Company’s legal counsel estimates that the infringement case may result in a
loss of P2,400,000 but considers the likelihood of losing the case as reasonably possible.

4. Dwayne Company’s legal counsel is convinced that the likelihood of losing the case is
probable, the potential amount of the loss, however is currently undeterminable.

5. Dwayne Company’s legal counsel is convinced that the likelihood of losing the case is
probable, the potential amount of the loss, based on the reliable evidences would be as
follows: 20% that the liability would be P1,600,000; 50% that the liability would be at
P2,000,000; 30% that the liability would be P2,400,000.

6. Dwayne Company’s legal counsel is convinced that the likelihood of losing the case is
probable, the potential amount of loss, based on reliable evidences would be around
P1,500,000 to P3,000,000.

PROBLEM 25-28 Contingencies

During 2016, Smith Company filed suit against West Company seeking damages for patent
infringement. In Smith’s December 31, 2016 financial statement, how should this be
reported? The choices are:
a. Accrue and Disclose
b. Disclose only
c. Accrue only
Chapter 25 - Introduction to Liabilities

d. Neither Accrue nor disclose

Assume the following independent cases:

1. It is virtually certain that Smith would be successful against West for an estimated
amount of P1,500,000.

2. It is probable that Smith would be successful against West for an estimated amount of
P1,500,000.

3. It is probable that Smith would be successful against West for an estimated amount of
P1,500,000, before the financial statements was issued, Smith was awarded P1,000,000
and received full payment thereof.

4.It is probable that Smith would be successful against West for an estimated amount of
P1,500,000, after the financial statements was issued, Smith was awarded P1,000,000 and
received full payment thereof.

5. It is reasonably possible that smith would be successful against West for an estimated
amount of P1,500,000.

6. During the year 2016, Smith won a litigation award for P1,500,000 which was tripled to
P4,500,00 to include punitive damages. The defendant, who is financially stable, has
appealed only the P3,000,000 punitive damages. Counsel is unable to estimate the outcome
of this appeal.

PROBLEMS 25-29 Bonus Computation

David Company decided to offer a bonus to its branch manager at 20% of net income
earned by the branch during the current year. The income for the branch was P3,090,000
before tax and before bonus for the current year. The income tax rate is 30%.

Questions:
Based on the above data, determine the following:
1. How much is the bonus if the bonus is based on the net income before bonus and tax?
a. P360,500 c. P379,474
b. P515,000 d. P618,000

2. How much is the bonus if the bonus is based on the net income after bonus but before
tax?
a. P360,500 c. P379,474
b. P515,000 d. P618,000

3. How much is the bonus if the bonus is based on the net income after bonus and tax?
a. P360,500 c. P379,474
b. P515,000 d. P618,000

PROBLEMS 25-30
Wades music emporium carries a wide variety of music promotion techniques-warranties
and premiums- to attract customers.
Chapter 25 - Introduction to Liabilities

Musical instrument and sound equipment are sold in a one-year warranty for replacement
of parts and labor. The estimated warranty cost, based on past experience, is 4% of sales.

The premium is offered on the recorded and sheet music. Customers receive a coupon for
two pesos spent on recorded music or sheet music. Customers may exchange 200 coupons
and P20 for an AM/FM radio. Wade pays P34 for each radio and estimates that 90% of the
coupons given to customers will be redeemed.

Wades total sales for 2016 were P2,000,000 from recorded music and sheet music.
Replacement parts and labor for warranty work totalled P164,000 during 2016. A total of
6,500 AM/FM radio used in the premium program are purchased during the year and there
were 1,200,000 coupons redeemed in 2016.

The accrual method is used by Wade 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, 2016, was shown below:

Inventory of Premium AM/FM radio P39,950

Estimated Premium Claims Outstanding 44,800
Estimated Liability from Warranties 136,000

Also on December 31, 2016, the estimated liability from warranties show P212,000
balance.

Questions: (Please assume that the selling price of the recorded music and sheet is an even
number)
Based on the above and the result of your audit, determine the amounts that will be shown
on the 2016 financial statements for the following:
1. Sales from musical instrument and sound production equipment
a. P6,000,000 c. P6,400,000
b. P5,400,000 d. P5,300,000

2. Warranty Expense
a. P240,000 c. P256,000
b. P216,000 d. P212,000

3. Premium expense
a. P75,600 c. P63,000
b. P108,000 d. P126,000

4. Inventory of AM/FM radio

a. P158,950 c. P39,950
b. P77,350 d. P56,950

5. Estimated liability for premiums

a. P86,800 c. P36,400
b. P65,800 d. P23,800
Chapter 25 - Introduction to Liabilities

PROBLEMS 25-31 Refinancing of loan, Notes Payable Interest and Non-Interest

Bearing
In connection with your audit of Riley Corporation’s financial statements for the year 2016,
you noted the following liability account balance as of December 31, 2015:

12% Notes payable P2,800,000

10% Notes payable 2,000,000

Transactions during 2016 and other information relating to Riley’s liabilities were as
follows:
a) The note is dated May 1, 2015 and is payable in four equal annual instalments of
P700,000 beginning May 1, 2016. The first principal and interest payment was made on
May 1, 2016.
b) The 10% P2,000,000 loan payable will mature on July 1, 2017. Interest on the is due
every July 1 and December 31. On December 1, 2016, the company entered into a
refinancing agreement with a bank to refinance the loan on a long-term basis. The
refinancing and roll over transactions was completed on December 31, 2016.
c) On January 1, 2016, The Company purchased delivery equipment by paying cash of
P200,000 and issuing a non-interest-bearing note payable of P2,000,000 due in 4 equal
annual installments starting December 31, 2016. The prevailing rate of interest of this type
of note is 12%.

Questions:
Based on the above data, determine the following:
1. How much is the carrying amount of the note issued for delivery equipment on initial
recognition?
a. P1,518,650 c. P1,271,000
b. P2,000,000 d. P2,200,000

2. Non-current portion of the notes payable as of December 31, 2016?

a. P5,600,000 c. P4,400,000
b. P4,244,995 d. P3,627,987

3. Current portion of notes payable as of December 31, 2016?

a. P1,100,000 c. P988,974
b. P1,055,000 d. P763,573

4. Accrued interest payable as of December 31, 2016?

a. Nil c. P224,000
b. P168,000 d. P200,000

5. Total interest expense for the year 2016?

a. P268,000 c. P662,000
b. P618,238 d. P352,327

PROBLEMS 25-32 Warranty, Premium and Bonus

You have been provided with the following data in connection with your audit of Bosh
Company for the year ended December 31, 2016, its first year of operations:
Chapter 25 - Introduction to Liabilities

Warranty expense P 85,000

Premium expense 270,000
Net income 1,935,000

Additional Information:
Bash Co. sells two products-washing machines and ovens. The washing machines carry
three-year warranty against manufacturer’s defects. Based on the reliable estimate,
warranty costs are estimated at P150 per machine. During 2016, Bosh Co. sold 1,200
washing machines and paid warranty costs of P85,000 which charged to warranty expense.

Premium is offered on the oven. Customers receive a coupon for each peso spent for the
oven. Customers may exchange 400 coupons and P20 for t-shirt. Bosh pays P45 for each t-
shirt and estimates that 60% of the coupons give to customers will be redeemed. Total
sales of the oven amounted to P1,200,000.

A total of 6,000 t-shirts used in the premium program were purchased during the year and
there were 500,000 coupons redeemed during the current year. Premium expense of
P270,000 was charged by the company when it purchased the 6,000 t-shirts.

Questions:
Based on the data, determine the following:
1. Estimated Warranty Payable, December 31, 2016
a. P95,000 c. P85,000
b. P180,000 d. P265,000

2. Estimated Premium Payable, December 31, 2016

a. P45,000 c. P13, 750
b. P31,250 d. P76,250

3. Adjusted net income during 2016

a. P2,000,000 c. P2,065,000
b. P1,990,000 d. P2,085,000

4. Assuming a bonus of 20% is given to the president based on net income after bonus and
before tax of 30%, how much is the bonus?
a. P240,917 c. P253,956
b. P344,167 d. P413,000

5. Assuming a bonus of 20% is given to the president based on the net income after bonus
and tax of 30%, how much is the bonus?
a. P240,917 c. P253,956
b. P344,167 d. P413,000

PROBLEM 25-33 Comprehensive

As part of your examination to audit the financial statements of Chris Company as of
December 31, 2016, you were able to gather the following data:

SSS Payable P 10,000

Philhealth Payable 9,000
Chapter 25 - Introduction to Liabilities

Estimated liabilities under guarantee agreement 110,000

Estimated warranties on goods sold 120,000
Deferred tax liability 40,000
Utilities Payable 6,000
Trade accounts payable net of debit balance in supplier’s
account of P30,000, net of unreleased checks of P20,000, and net
of postdated checks of P12,000. 170,000
Notes Payable:
Arising from purchase of goods 200,000
Arising from 4-year bank loan 400,000
Arising from advances by officers, due in 3 years 300,000
Share dividends payable 60,000
Dividends in arrears, preferred shares undeclared 100,000
Share options outstanding 120,000
Convertible bonds payable due July 1, 2017 1,000,000
Serial bonds payable maturing in semi-annual instalments of P40,000 800,000
Accrued interest expense 4,000
Advances from customers 25,000
Unearned rent income 36,000
Unearned interest on receivables 3,500
Income taxes payables 45,000
Cash dividends payable 100,000
Property dividends payable 120,000
Notes receivable, net of P40,000 credit balance 260,000
Cash in bank-Metrobank 1,100,000
Overdraft with Metrobank 100,000
Cash in bank-RCBC 800,000
Overdraft with PNB 80,000
Security deposit received from lessee 89,000
Container’s deposit 45,000
Reserve for contingencies 220,000
Loans payable-10% 150,000
Loans payable-12% 270,000
Notes receivable discounted 20,000
Unused letters for credit 10,000
Financial liability designated as fair value through profit or loss 200,000

Additional information
 Cash in payment of accounts payable to supplier on December 31, 2016 amounting
to P8,000 was not recorded by Chris Company.
 The 10% loan payable is due on June 30, 2017. Interest on the loan is due every July
1 and December 31. On December 31, 2016, Chris Co. entered into a refinancing
agreement with a bank to refinance the loan on a long-term basis. The refinancing
and roll over transactions was completed on December 31, 2016.
 The 12% payable is due July 1, 2018. The loan agreement requires Chris to maintain
a current ratio of 3:1. If the current ratio falls before the amount, the loan becomes
payable on demand. As of December 31, 2016, the current ration of the company is
2:5:1. On January 5, 2017, the bank agreed not to demand payment giving Chris Co.
one-year to rectify the breach of agreement.
Chapter 25 - Introduction to Liabilities

Questions:
Determine the following as of December 31, 2016:
1. Current liabilities
a. P2,527,500 c. P2,487,500
b. P2,727,500 d. P2,616,500

2. Noncurrent liabilities
a. P1,699,000 c. P1,659,000
b. P2,009,000 d. P1,779,000

3. Total liabilities
a. P4,226,500 c. P4,146,500
b. P4,426,500 d. P4,395,500