Chapter 9 - Audit of Liabilities Roque

IX  –  AUDIT  AUDIT OF LIABILITIES

PROBLEM NO. 1  –  Current and noncurrent liabilities

You were able to obtain the following from the accountant for Agdangan Corp. related to the company’s liabilities as of December 31, 2010.

Accounts Payable  Notes Payable Payable –   – trade trade  Notes Payable Payable –   – bank bank Wages and salaries payable Interest payable Mortgage notes payable –  payable – 10% 10% Mortgage notes payable –  payable – 12% 12% Bonds Payable

P

650,000 190,000 800,000 15,000 ? 600,000 1,500,000 2,000,000

The following additional information pertains to these liabilities. a. All trade notes payable are due within six months from the end of the reporting period.  b. Bank notes-payable include two separate notes payable to Allied Bank. (1) A P300,000, 8% note issued March 1, 2008, payable on demand. Interest is payable every sixmonths. (2) A 1-year, P500,000, 11 ½ % not issued January 2, 2010. On December 30, 2010, Agdangan negotiated a written agreement with Allied Bank to replace the note with a 2-year, P500,000, 10% note to be issued January 2,2011. The interest was paid on December 31, 2010. c. The 10% mortgage note was issued October 1, 2007, with a term of 10 years. Terms of the note give the holder the right to demand immediate payment if the company fails to make a monthly interest payment within 10 days of the date the payment is due. As of December 31, 2016, Agdangan Agdangan is three months behind in paying its required interest payment. d. The 12% mortgage note was issued May 1,2004, with a term of 20 years. The current principal amount due is P1,500,000. Principal and interest payable annually on April 30. A payment of P220,000 is due April 30, 2011. The payment includes interest of P180,000. e. The bonds payable is 10-year, 8% bonds, issued June 30, 2001. Interest is payable semi-annually every June 30 and December 31.

QUESTIONS: Based on the above and the result of your audit, answer the following. 1. Interest payable as of December 31, 2010 is a. P155,000 c. P143,000  b. P203,000 d. P215,000

2. The portion of the Note Payable-bank Payable-bank to be reported under current liabilities as of December 31, 2010 is a. P300,000 c. P500,000  b. P800,000 d. P 0 3. Total current liabilities as of December 31, 2010 is a. P3,950,000 c. P4,138,000  b. P3,938,000 d. P 0 4. Total noncurrent liabilities as of December 31, 2010 is a. P1,760,000 c. P2,560,000  b. P3,960,000 d. P1,960,000

Answers: 1)C

2)A

3)B

4)D

Suggested Solution:

Question No. 1 P300,000 note payable to bank (P300,000 x 8% x 4/12) Mortgage note payable –  payable  – 10% 10% (P600,000 x 10% x 3/12) Mortgage note payable –  payable  – 12% 12% (P1,500,000 x 12% x 8/12) Total interest payable, 12/31/10

P

8,000 15,000 120,000 143,000

Question No. 2  Note payable payable to bank bank –   – payable payable on demand

P 300,000

The P500,000 note payable to bank will be classified as noncurrent because it was refinanced on a long term basis as of December 31, 2010.

Question No. 3 Accounts Payable  Notes Payable Payable –   – trade trade  Notes Payable Payable –   – bank bank (see no. 2) Wages and salaries payable Interest payable (see no. 1) Mortgage note payable –  payable  – 10% 10% (with breach of loan covenant) Mortgage note payable –  payable  –  12%  12% (P220,000 –  (P220,000 – P180,000) P180,000) Bonds payable, due 7/1/11 Total current liabilities, 12/31/10

P

650,000 190,000 300,000 15,000 143,000 600,000 40,000 2,000,000 P3,938,000

 In accordance accordance with the revised revised PAS 1 par. 69, an entity shall shall classify a liability as current when: (a) (b) (c) (d)

it expects to settle the liability in its normal operating cycle; it holds the liability primarily for the purpose of trading; the liability is due to be settled within twelve twelve months after the reporting period; or the entity does not have an unconditional right to defer settlement of the liability for at least twelve months after the reporting period.

 An entity shall classify classify all other other liabilities liabilities as non-current. non-current.

When an entity breaches an undertaking under a long-term loan agreement on or before the end of the reporting period with the effect that the liability becomes payable on demand, the liability is classified as current, even if the lender has agreed, after the reporting period and before the authorization of the  financial statements for issue, not to demand payment as a consequence consequence of the breach. The liability is current, because at the end of the reporting period, the entity does not have an unconditional right to defer its settlement for at least twelve months after that date. (PAS 1 par. 74)

 However, the liability liability is classifies classifies as non-current if the lender lender agreed agreed by the end of the reporting period to  provide a period period of grace grace ending ending at least least 12 months after after the reporting period, period, within within which the entity can rectify the breach and during which the lender cannot demand immediate repayment. [PAS 1 par. 75]

Question No. 4  Notes payable payable –   – bank bank (see no. 2) Mortgage note payable –  payable  –  12%  12% (P1,500,000 –  (P1,500,000 – P40,000) P40,000) Total noncurrent liabilities, 12/31/10

P

500,000 1,460,000 P 1,960,000

PROBLEM NO. 2  –  Current and noncurrent liabilities

Atimonan Corporation is selling audio and video appliances. The company’s fiscal year ends on March 31. The following information relates to the obligations of the company as of March 31, 2010:

 Notes Payable Payable

Atimonan has signed several long-term notes with financial institutions. The maturities of these notes are given below. The total unpaid interest for all of these notes amounts to P408,000 on March 31, 2010.

Due date April 31, 2010 July 31, 2010 September 1, 2010 February 1, 2011 April 1, 2011 –  2011 – March March 31, 2012

Amount P 720,000 1,080,000 540,000 540,000 3,240,000 P 6,120,000

Estimated warranties Atimonan has a one-year product warranty on some selected items. The estimated warranty liability in sales made during the 2008-2009 fiscal year and still outstanding as of March 31, 2009, amounted to P302, 400. The warranty costs on sales made from April 1, 2009 to March 31, 2010, are estimated at P756,0 00. The actual warranty costs incurred during 2009-2010 f iscal year are as follows:

Warranty claims honored on 2008-2009 sales Warranty claims honored on 2009-2010 sales Total

P 302,400 342,000 P 644,400

Trade payables Accounts payable for supplies, goods, and services purchases on open account amount to P672,000 as of March 31, 2010.

Dividends On March 10, 2010, Atimonan’s board of directors declared a cash dividend of P0.30 per o rdinary share and a 10% ordinary share dividend. Both dividends were to be distributed on April 5, 2010 to shareholders on record at the close of business on March 31, 2010. As of March 31, 2010 Atimonan has 6 million, P2  par value, ordinary shares shares issued and outstanding. outstanding.

Bonds payable Atimonan issued P6,000,000, 12% bonds, on October 1, 2004 at 96. The bonds will mature on October 1, 2014. Interest is paid semi-annually on October 1 and April 1. Atimonan uses the straight line method to amortize bond discount.

QUESTIONS: Based on the foregoing information, determine the adjusted balances of the following as of March 31,2010:

1. Estimated warranty payable

a. P414,000  b. P756,000

c. P 302,400 d. P1,058,400

2. Unamortized bond discount a. P132,000  b. P108,000

c. P 240,000 d. P 120,000

3. Bond interest payable a. P360,000  b. P300,000

c. P 180,000 d. P 0

4. Total current liabilities a. P7,734,000  b. P6,126,000

c. P 6,534,000 d. P 4,734,000

5. Total noncurrent liabilities a. P9,240,000  b. P9,132,000

c. P 9,108,000 d. P 9,000,000

Answers: 1) A 2) B

3) A

4) C

5) B

Suggested Solution: Question No. 1 Warranty payable, 3/31/09 Add warranty expense accrued during 2009-2010 Total Less payments during 2009-2010 Warranty payable, 3/31/10

P 302,400 756,000 1,058,400 644,400 P 414,000

Question No. 2 Bond discount, 10/1//04 (P6,000,000 (P6,000,00 0 x .04) Discount amortization, amortization, 10/1/04 to 3/31/10 (P240,000 x 5.5/10) Bond discount, 3/31/10

P 240,000 132,000 P 108,000

Question No. 3 Bond interest payable, 10/1/09 to 3/31/10 (P6,000,000 (P6,000,00 0 x 12% x 6/12)

P 360,000

Question No. 4  Notes payable payable –   – current current (maturing up to 3/31/11) Accrues interest payable –  payable  – Notes Notes Payable Estimated warranty payable (see no. 1) Accounts payable Cash dividend payable (6 million shares x P0.30) Accrued interest payable –  payable  – Bonds Bonds payable Total current liabilities

P 2,880,000 408,000 414,000 672,000 1,800,000 360,000 P 6,534,000

Question No. 5  Notes payable payable –   – noncurrent noncurrent Bonds payable, net of discount of P108,000 Total noncurrent liabilities

P 3,240,000 5,892,000 P 9,132,000

PROBLEM NO. 3 – Various  – Various current liabilities

The following information relates to Candelaria Company’s obligations as of December 31, 2010. For each of the numbered items, determine the amount if any, that should be reported as current liability in the Candelaria’s December 31, 2010 statement of financial position .

1. Accounts payable: Accounts payable per general ledger control amounted to P5,440,000, net of P240,000 debit  balances in suppliers’ suppliers’ accounts. The unpaid voucher voucher file included the following items items that had had not  been recorded recorded as of of December December 31, 2010: 2010: a) A Company  –   P244,000 merchandise shipped on December 31, 2010, FOB destination; received on January 10, 2011.  b) B, Inc. –  Inc. –  P192,000  P192,000 merchandise shipped on December 26, 2010, FOB shipping point; received on January 16, 2011. c) C Super Services –  Services  –  P144,000  P144,000 janitorial services for the three-month period ending January 31, 2011. d) MERALCO –  MERALCO –  P67,200  P67,200 electric bill covering the period December 16, 2010 to January 15, 2011. On December 28, 2010, a supplier authorized Candelaria to return goods billed at P160,000 and shipped on December 20, 2010. The goods were returned by Candelaria on December 28, 2010,  but the P160,000 P160,000 credit credit memo memo was not received received until until January 6, 2011. a. P5,923,200  b. P5,601,600

c. d.

P5,712,000 P5,841,600

2. Payroll: Items related to Candelaria’s payroll payrol l as of December 31, 2010 are: Accrued salaries and wages P776,000 Payroll deductions for: Income taxes withheld 56,000 SSS contributions 64,000 Philhealth contributions contributions 16,000 Advances to employees 80,000 a. P776,000  b. 832,000

c. d.

P992,000 P912,000

3. Litigation: In May, 2010, Candelaria became involved in a litigation. The suit being contested, but Candelaria’s lawyer believes there is probable that Candelaria may be held liable for damages estimated in the range between P2,000,000 and P3,000,000 and no amount is a better estimate of  potential liability than any other amount. amount. a. P 0  b. P3,000,000

c. d.

P2,000,000 P2,500,000

4. Bonus obligation: Candelaria Company’s president gets an annual  bonus of 10% of net income after bonus and income tax. Assume the tax rate of 30% and the correct income bef ore bonus and tax is P9,600,000. P9,600, 000. (Ignore the effects of other given items on net income.) a. P 722,600  b. P2,240,000

c. d.

P395,000 P628,000

5.  Note payable: payable: A note payable to the Bank of the Philippine Islands for P2,400,000 is outstanding on December 31, 2010. The note is dated October 1, 2009, bears interest at 18%, and is payable in three equal annual installment of P800,000. The first interest and principal payment was made on October 1, 2010. a. P800,000  b. P 72,000

c. P908,000 d. P872,000

6. Purchase commitment: During 2010, Candelaria entered in a noncancellable commitment to purchase 320,000 units of inventory at fixed price of P5 per unit, delivery to be made in 2011. On December 31, 2010 the  purchase price of this inventory item had fallen to P4.40 per unit. The goods covered by the  purchase contract were were delivered delivered on January 28, 2011.

a. P 0  b. P1,408,000

c. P1,600,000 d. P 192,000

7. Deferred taxes: On December 31, 2010, Candelaria’s deferred income tax account has a 2010 ending credit balance of P772,800, consisting of the following items: Caused by temporary differences in accounting Deferred tax For gross profit on installment installment sales P376,000 Cr For depreciation on property and equipment 576,000 Cr For product warranty expense 179,200 Dr P772,000 Cr a. P772,800  b. P196,800

c. d.

P952,000 P 0

8. Product warranty: Candelaria has one year product warranty on selected items in its product line. The estimated warranty liability on sales made during 2009, which was outstanding as of December 31, 2009, amounted to P416,000. The warranty costs on sales made in 2010 are estimated at P1,504,000. Actual warranty costs incurred during 2010 are as follows: Warranty claims honored on 2009 sales P 416,000 Warranty claims honored on 2010 sales 992,000 Total warranty claims honored P 1,408,000 a. P 0  b. P96,000

c. P1,504,000 d. P 512,000

9. Premiums: To increase sales, Candelaria Company inaugurated a promotional campaign on June 30, 2010. Candelaria placed a coupon redeemable for a premium in each package of product sold. Each  premium costs costs P100. A premium is is offered to customers who send in 5 coupons coupons and a remittance remittance of P30. The distribution cost per premium is P20. Candelaria estimated that only 60% of the coupons issued will be redeemed. For the six months ended December 31, 2010, the following is available: Packaged of product sold 160,000 Premiums purchased 16,000 Coupons redeemed 64,000 a. P1,728,000 c. P1,152,000  b. P1,600,000 d. P 576,000 10. Due to Five Six Finance company: Candelaria’s accounting records show that as of December 31, 2010, P1,280,000  was due to Five Six Finance Company for advances made against P1,600,000 of trade accounts receivable assigned to the finance company with recourse. a. P 0 c. P1,600,000  b. P 320,000 d. P1,280,000

Answers: 1)D

2)D

3)D

4)D

5)D

6)D

7)D

8)D

9)D

10)D

Suggested Solution:

Question No. 1 Accounts payable per general ledger Debit balances in suppliers’ accounts  accounts   Goods in transit on 12/31/10, FOB shipping point Unrecorded purchase return Accounts payable, as adjusted Accrued janitorial expenses (P144,000 x 2/3) Accrued utilities (P67,200 x 15/30) Total

P5,440,000 240,000 192,000 (160,000) 5,712,000 96,000 33,600 P5,841,600

Question No. 2 Accrued salaries and wages Income taxes withheld SSS contributions contributi ons payable Philhealth contributions contributio ns Total

P776,000 56,000 64,000 16,000 P912,000

Question No. 3 Midpoint of the range [(P2,000,000 [(P2,000,0 00 + P3,000,000)/2] P3,000,000)/ 2]

P2,500,000

 PAS 37 par. 36 states that the amount recognized recognized as a provision should be the best estimate of the expenditure required to settle the present obligation at the end of the reporting period. Par. 39 further  states that where where there there is a continuous continuous range range of possible possible outcomes, outcomes, and each point point in that range is a likely as any other, the mid-point of the range is used.

Question No. 4 B = 10% (P9,600,000 –  (P9,600,000 –  B –   B –  T)  T) T = 30% (P9,600,000 –  (P9,600,000 –  B)  B) T = P2,880,000 - .3B

B = 10% [P9,600,000 –  [P9,600,000 –  B –   B –  (P2,880,000  (P2,880,000 - .3B)] B = 10% (P9,600,000 –  (P9,600,000 –  B –   B –  P2,880,000  P2,880,000 + .3B) B = 10% (P6,720,000 - .7B) B = P672,000 - .07B 1.07B = P672,000 B = P628,000 (rounded (rounded off)

Question No. 5 Principal amount due, 10/1/11 Accrued interest payable (P1,600,000 x 18% x 3/12) Total

P800,000 72,000 P872,000

Question No. 6 Estimated liability for purchase commitment [320,000 x (P5  – P4.40)]  – P4.40)]

P192,000

 If an entity has a contract that is onerous, the present obligation under the contract shall be recognized and measured as a provision. ( PAS PAS 37 par. 66)

 An onerous contract is a contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it.

Question No. 7 The revised PAS 1 par. 56 states that when an entity presents current and non-current assets, and current and non-current liabilities, as separate classifications on the face of the statement of  financial position, it shall shall not classify classify deferred deferred tax tax assets assets (liabilities) (liabilities) as current assets (liabilities) (liabilities)..

Question No. 8 Warranty payable, 12/31/09

P

416,000

Add: Warranty expense accrued during 2010

1,504,000

Total

1,920,000

Less: Payments Payments during 2010 Warranty Payable, 12/31/10

1,408,000 P

512,000

Question No. 9 Estimated coupons to be redeemed (160,000 x 60%)

96,000

Less coupons redeemed

64,000

Coupons outstanding

32,000

Divide by exchange rate Premiums to be issued Multiply by net premium cost (P100 + P20 –  P20  – P30) P30) Estimated liability for coupons, 12/31/10

5 6,400 P90 P576,000

Question No. 10 This transaction involves assignment of accounts receivable, wherein the company obtained a loan using the receivable as security. Accounts receivable  –  assigned  assigned will be included in trade and other receivables, while the related loan will be reported under current liabilities.

liabilities –  warranty  warranty and premium PROBLEM NO. 4 Estimated liabilities –  Dolores’ Music Emporium Emporiu m carries a wide variety of music promotion techniques –  warranties –  warranties and premiums  –  to  to attract customers. Musical instrument and sound equipment eq uipment are sold in a one-year warranty for replacement r eplacement of parts and labor. The estimated warranty cost, based on past experience, is 2% of sales. The premium is offered on the recorded and sheet music. Customers receive a coupon for each peso spent on recorded music or sheet music. Customers may exchange 200 coupons and P20 for an AM/FM radio. Dolores pays P34 for each radio and estimates that 60% of the coupons given to customers will be redeemed. Dolores’ total sales for 2010 were P57,600,000 –   P43,200,000 from musical instrument and sound reproduction equipment and P14,400,000 from recorded music and sheet music. Replacement parts and labor for warranty work totaled P1,312,000 during 2010. A total of 52,000 AM/FM radio used in the  premium program were purchased during the year year and there were 9,600,000 coupons redeemed redeemed in 2010.

The accrual method is used by Dolores to account for the warranty and premium costs for financial reporting  purposes. The balance in the accounts related to warranties and premiums premiums on January 1, 2010, were as shown below: Inventory of Premium AM/FM radio Estimated Premium Claims Outstanding Estimated Liability from Warranties

P 319,600 358,000 1,088,000

QUESTIONS: Based on the above and the result of your audit, determine the amounts that will be shown on the 2010 financial statements for the following: 1. Warranty expense a. P 864,000  b. P1,152,000

c. P1,312,000 d. P 640,000

2. Estimated liability from warranties a. P 864,000 c. P1,088,000  b. P1,312,000 d. P 640,000 3. Premium expense a. P 604,800 c.  b. P1,468,800 d. 4. Inventory of AM/FM radio a. P375,600 c.  b. P319,600 d. 5. Estimated liability for premiums a. P604,800 c.  b. 291,200 d. Answers: 1) A; 2) D;

3) A;

4) D;

P 864,000 P 1,008,000 P 618,800 P 455,600 P 507,600 P 358,400

5) B

Suggested Solution: Question No. 1 Warranty expense (P43,200,000 (P43,200,00 0 x 2%)

Question No. 2

P864,000

Estimated liability from warranties, 1/1/10

P1,088,000

Add: Warranty expense for 2010

864,000

Total

1,952,000

Less: Actual expenditures expenditures for 2010

1,312,000

Estimated liability from warranties, 12/31/10

640,000

Question No. 3 Premium expense [(14,400,000 x 60%)/ 200 x P14]

P604,800

Question No. 4 Inventory of premium, premium, 1/1/10

P

319,600

Add: Premium purchases (52,000 x P34)

1,768,000

Total premium available

2,087,600

Less: Premiums issued (9,600,000/200 (9,600,000/2 00 x P34)

1,632,000

Inventory of premium, 12/31/10

455,600

Question No. 5 Estimated premium claims outstanding, 1/1/10

P358,400

Add: Premium expense for 2010

604,800

Total

963,200

Less: Premiums issued (P 9,600,000/200 9,600,000/200 x P14)

672,000

Estimated premium claims outstanding, 12/31/10

291,200

 Provisions and contingent contingent liabilities PROBLEM NO. 5 –  Provisions

The following information relates to Alabat Company as of December 31, 2010. Answer the following questions relating to each of the independent situations as requested. 1. Beginning 2010, Alabat Company began marketing a new beer called “Red Colt.” To help promote the product, the management is offering a special beer mug to each customer for every 20 specially marked bottle caps of Red Colt. Alabat estimates that out of the 300,000 bottles of Red Colt sold during 2010m only 50% of the marked bottle bot tle caps will be redeemed. For the year 2010, 8,000 8,00 0 mugs were ordered by the company at a total cost of P360,000. A total of 4,500 mugs were already distributed to customers. What is the amount of the liability that Alabat Company should report on its December 31, 2010 statement of financial position? a. P135,000 c. P337,500  b. P202,500 d. P360,000 2. On January 2, 2008, Alabat Company introduced a new line of products that carry a three-year warranty against factory defects. Estimated warranty costs related to peso sales are as follows: 1% of sales in the year of sale, 2% in the year after sales and 3% in the second year after sale. Sales and actual warranty expenditures expenditures for the period 2008 to 2010 were as follows:

2008 2009 2010

Sales P100,000 250,000 350,000 P700,000

Actual Warranty Expenditures P 750 3,750 11,250 P15,750

What amount should Alabat report as warranty expense in 2010? a. P 3,500 c. P11,500  b. P 11,250 d. P21,000

3. During 2010, Alabat Company guaranteed a supplier’s P500,000 loan from a bank. On October 1, 2010, Alabat was notifies that the supplier had defaulted on the loan and filed for bankruptcy  protection. Counsel believes Alabat will probably have to pay between P250,000 and P450,000 under its guarantee. As a result of the supplier’s bankruptcy, Alabat entered into a contract in December 2010 to retool its machines so that Alabat could accept parts from other suppliers. Retooling costs are estimated to be P300,000. What amount should Manfred report as a liability in its December 31, 2010, statement of financial position? a. P250,000 c. P350,000  b. P450,000 d. P650,000

A court case decided on 21 December 2010 awarded damages against Alabat. The judge has announced that the amount of damages will be set at a future date, expected to be in March 2011.

Alabat has received advice from its lawyers that the amount of the damages could be anything  between P20,000 P20,000 and P7,000,000. As of December 31, 2010, how much should be recognized in the statement of financial position regarding this court case? a. P 20,000  b. P3,150,000

c. P7,000,000 d. P 0

Alabat’s directors decided on 3 November 2010 to restructure the company’s operations as follows: a) Factory T would be closed down and put on the market for sale.  b) 100 employees working in Factory T would be retrenched effective 30 November 2010 and would be paid their accumulated entitlements p lus 3 months’ wages. c) The remaining 20 employees working in Factory T would be transferred to Factory X, which would continue operating. d) 5-head-office staff would be retrenched effective 31 December 2010 and would be paid their accumulated entitlements plus 3 month’s wages. As at 31 December 2010 the following transactions and events had occurred: 







Factory T was shut down on 30 November 2010. An offer of P80M had been received for Factory T; however there was no binding sales agreement The 100 employees had been retrenched, had left and their accumulated entitlements had been  paid, however an amount of P1,520,000, P1,520,000, representing a portion of the 3 months’ wages for the retrenched employees, had still not been paid. Costs of P460,000 were expected to be incurred in transferring the 20 employees to their new work in Factory X. The transfer will occur on 15 January J anuary 2011. Four of the five-head-office staff had been retrenched, had left and their accumulated entitlements, including the 3 months’ wages, had been paid.   However one employee, D. Terminator, remained on to complete administrative tasks relating to the closure of Factory T and the transfer of staff to Factory X. D. Terminator was expected to stay until 31 January 2011. D. Terminator’s salary for January would wou ld be P80,000 and his retrenchment package would be P260,000, all of which would be paid on the day he left. He estimated that he would spend 60% of his time administering the closure of Factory T, 30% of his time administering the transfer of staff to Factory X and the remaining 10% on general administration. administration.

Calculate the amount of the restructuring provision to be recognized in Alabat’s financial statements as at 31 December 2010. a. P 116,000  b. P1,828,000

Answers: 1) A;

c. P93,000 d. P89,000

2) D;

3) C;

4) D;

5) B;

Suggested Solution:

Question No. 1 Total estimated mugs to be issued [(300,000 [(300,00 0 x 50%)/20]

7,500

Less mugs issued

4,500

Balance

3,000

Multiply by premium cost (P360,000/8,000) (P360,000/8, 000) Estimated premium liability, 12/31/10

45 P135,000

Question No. 2 Warranty expense for 2010 (P350,000 x 6%)

P21,000

Question No. 3 Provision for guarantee, guarantee, 12/31/10 [(P250,000 + P450,000) / 2]

P350,000

 A provision is a liability of uncertain timing or amount. The amount recognized as a provision  shall be the best estimate of the expenditure expenditure required required to settle the the present present obligation obligation at the end of the reporting period. (PAS 37 par. 36) Where there is a continuous range of possible outcomes, and each point in that range is as likely as any other, the mid-point of the range is used (PAS 37 par. 39)

Question No. 4 There is a present obligation and the obligating event has occurred, however the amount cannot be reliably measured as the estimated range is too great. Therefor e, no liability can be recognized. This will only be disclosed as a contingent liability.

Question No. 5 Unpaid salaries of retrenched employees D. Terminator’s retrenchment package  package  

P1,520,000 260,000

D. Terminator’s salary related to administration of the closure (P80,000 x 60%)

48,000 P1,828,000

 A restructuring restructuring is a program that is planned and controlled controlled by management, management, and materially changes either: (a) The scope of a business undertaken by an entity; or (b) The manner in which that business is conducted. conducted.

 A restructuring restructuring provision shall include only the direct expenditures expenditures arising from the restructuring, restructuring, which are those that are both (a)  Necessarily  Necessarily entailed entailed by the restructuring; restructuring; and (b)  Not associated associated with the ongoing activities activities of the entity. (PAS 37 par. 80)  A restructuring restructuring provision provision does not include such costs costs as: (a)  Retaining or relocating continuing staff; (b)  Marketing;  Marketing; or (c)  Investment in new systems systems and distribution networks.

These expenditures relate to the future conduct of the business and are not liabilities for restructuring at the end of the reporting period. Such expenditures are recognized on the same basis as if they arose independently of a restructuring.

 Provisions, contingent liabilities, liabilities, and contingent contingent assets assets PROBLEM NO. 6  –  Provisions, Burdeos Corporation, a listed company, is a manufacturer of confectionery and biscuits. Its end of reporting period is December 31 Relevant extracts from its financial statements at 31 December 2009 are as follows:

Current liabilities Provision Provision for warranties

P270,000

 Non-current liabilities liabilities Provision Provision for warranties

P180,000

 Note 36 –  36 –  Contingent   Contingent liabilities Burdeos is engaged in litigation with various parties in relation to allergic reactions to traces of peanuts alleged to have been found in packets of fruit gums. Burdeos strenuously denies the allegations and, as at the date of authorizing the financial statements for issue, is unable to estimate the financial effect, if any, of any costs or damages that may be  payable to the plaintiffs. plaintiffs. The provision for warranties at December 31, 2009 was calculated using the following assumptions: There was no balance carried forward from the prior year. Estimated cost of repairs –  repairs  – products products with minor defects

P1,000,000

Estimated cost of repairs –  repairs  – products products with major defects

P6,000,000

Expected % of products sold during 2009 having no Defects in 2010

80%

Expected % of products sold during 2009 having Minor defects in 2010

15%

Expected % of products sold during 2009 having Major defects in 2010

5%

Expected timing of settlement of warranty payments -

Those with minor defects

Expected timing of settlement of warranty payments -

Those with major defects

During the year ended December 31, 2010 the following occurred:

All in 2010 40% in 2010 60% in 2011

1. In relation to the warranty provision of P450,000 at December 31, 2009, P200,000 was paid out of the provision. Of the amount paid, P150,000 was for products with minor defects and P50,000 was for products with major defects, all of which related to amounts that had been expected to be paid in 2010. 2. In calculating its warranty provision for December 31, 2010, Burdeos made the following adjustments to the assumptions used for the prior year: Estimated cost of repairs –  repairs  – products products with minor defects

No change

Estimated cost of repairs –  repairs  – products products with major defects

P5,000,000

Expected % of products sold during 2010 having no Defects in 2011

85%

Expected % of products sold during 2010 having Minor defects in 2011

13%

Expected % of products sold during 2010 having Major defects in 2011

2%

Expected timing of settlement of warranty payments -

Those with minor defects

Expected timing of settlement of warranty payments -

Those with major defects

All in 2011 40% in 2011 60% in 2012

3. Burdeos determined that part of its plant and equipment needed an overhaul  –  the  the conveyer belt on one of its machines would need to be replaced in about December 2011 at an estimated cost of P250,000. The carrying amount of the conveyer belt at December 31, 2009 was P140,000. Its original cost was P200,000.. 4. Burdeos was unsuccessful in its defense of the peanut allergy case and was ordered to pay P1,500,000 to the plaintiffs. As at December 31, 2010 Burdeos had paid P800,000. 5. Burdeos commenced litigation against one of its advisers for negligent advise given on the original installation installation of the conveyers belt referred to in (4) above. In October 2010 the court found in favor of Burdeos. The hearing for damages had not been scheduled as at the date the financial statements for 2010 were authorized authorized for issue. Burdeos estimated that it would receive about P425,000. 6. Burdeos signed an agreement with Craft Bank to the e Burdeos would guarantee a loan made by Craft Bank to the subsidiary, Burgis Ltd. Burgis’ loan with Craft B P3,200,000 as at December 31, 2010. Burgis was in financial position at December 31, 2010.

QUESTIONS: Based on the above and the result of your audit, answer the f ollowing 1. The warranty expense in 2010 is a. P100,000 c. P400,000  b. P160,000 d. P230,000 2. The provision for warranties as of December 31, 2010 is a. P580,000 c. P230,000  b. P480,000 d. P410,000 3. The provision for warranties to be reported as current liabilities liabilities on December 31, 2010 is a. P220,000 c. P150,000  b. P400,000 d. P330,000 4. The provision for warranties to be reported as noncurrent as of December 21, 2010 is a. P 80,000 c. P260,000  b. P150,000 d. P330,000 5. Total provisions to be reported in the statement of financial position as of December 31, 2010 is a. P 480,000 c. P 410,000  b. P1,180,000 d. P1,360,000

Answers: 1) B; 2) D; 3) A; 4) A; 5) C

Suggested Solution:

Question No. 1  No defects –  defects – 85% 85%

P

0

Minor defects (P1,000,000 (P1,000,00 0 x 13%)

130,000

Major defects (P5,000,000 x 2%)

100,000

Increase in provision in 2010

230,000

Unused amounts reversed in 2010 (P270,000 –  (P270,000  – P200,000) P200,000)

( 70,000)

Warranty Expense in 2010

P 160,000

Where the provision being measured involves a large population of items, the obligation is estimated by weighing all possible outcomes by their associated probabilities. The name for this statistical method of estimation is ‘expected value’.

Question No. 2 Balance, 1/1/10 (P270,000 + 180,000)

P450,000

Amounts used in 2010

(200,000)

Increase in provision in 2010

230,000

Unused amounts reversed in 2010

(

70,000)

Balance, 12/31/10

P 410,000

 Alternative  Alternative computation: computation: Increase in provision in 2010 Balance of provision from 2009 payable in 2011 Balance, 12/31/10

P230,000 180,000 P410,000

 A provision shall be used used only for expenditures expenditures for which the the provision provision was originally originally recognized. recognized.  Provisions shall be reviewed at the end of each reporting period and adjusted to reflect the current best estimate. If it is no longer probable that an outflow of resources embodying economic benefits will be required to settle the obligation, the provision shall be reversed.

Question No. 3 Balance of provision from 2009 payable in 2011

P 180,000

Increase in provision in 2010 Minor defects Major defects (P100,000 x 20%) Provision for warranties –  warranties – current current

130,000 20,000 P 330,000

Question No. 4 Provision for warranties, 12/31/10

P410,000

Less current provision for warranties

330,000

 Non-current provision provision for warranties warranties

P 80,000

Question No. 5 Provision for warranties, 12/31/10

P410,000

The other items should be treated as follows:  Expected overhaul –  overhaul –  not  not a provision; Burdeos has no present obligation to conduct over haul. Rather, it is evidence that the conveyer belt’s  useful life has been shortened. Unpaid amount of P700,000 (re peanut allergy case) –  case)  –  not   not a provision; there is no uncertainty regarding timing or amount of settlement. settlement. The amount should be included as part of trade and other payables. Claim for damages against the entity’s advisers –  advisers –  contingent  contingent asset. Guarantee –  Guarantee –  not   not a provision; although the entity has a present obligation under the guarantee; it is not  probable that an outflow outflow of economic economic benefits benefits will be required required to settle settle the obligation obligation since Burgis Burgis was in a strong financial position at December 31, 2010. The guarantee would be disclosed as a contingent liability.

 Bonds Payable Payable PROBLEM NO. 7 –  Bonds Gumaca Corporation authorized the sale of P2,000,000 of 12%, 10 year debentures on January 1, 2005. Interest is payable on January 1 and July 1. The entire issue was sold on April 1, 2005, at 102 plus accrued interest. On April 1, 2010, P1,000,000 of the bond issue was reacquired and retired at 99 plus accrued interest. On June 30, 2010, the remaining bonds were reacquired at 97 plus accrued interest and refunded with an issue of P1,600,000 of 9% bonds which were sold at 100. QUESTIONS: Based on the above and the result of your audit. Determine the following: ( Use straight line method to amortize premium or discount) 1. Total cash receive from the sale of P2 million bonds on April 1, 2005 a. P2,100,000

c. P2,040,000

 b. P2,000,000 P2,000,000

d. P2,120,000 P2,120,000

2. Interest expense for 2005 a. P180,000 c. P 157,241  b. P183, 077 d. P176,923 3. Carrying amount of bonds payable as of December 31, 2005 a. P2,037,241 c. P2,036,923  b. P2,042,759 d. P2,043,077 4. Gain or loss on retirement of P1 million bonds on April 1, 2010 a. P19,744 gain c. P 256 gain  b. P19,744 loss d. P19, 828 gain 5. Gain or loss on retirement of remaining bonds on June 30, 2010 a. P39,231 loss c. P 20,679 gain  b. P39,231 gain d. P39,310 gain

 Answers: 1) A; 2) D; 3) C; 4) A; 5) B

Suggested Solution: Question No. 1 Issue price (P2,000,000 x 1.02)

P2,040,000

Accrued interest (P2,000,000 x 12% x 3/12) Total cash received from sale of bonds

60,000 P2,100,000

Question No. 2  Nominal interest interest (P2,000,000 (P2,000,000 x 12% x 9/12) 9/12)

P180,000

Less premium amortization for 2005 (P40,000* x 9/117**) Interest expense for 2005

3,077 P176,923

*(P2,000,000 x .02) ** 120 months (10 years) –  years) –  3  3 months (1/1/2005 to 4/1/2005) Question No. 3 Carrying amount, 4/1/2005 (see no. 1)

P2,040,000

Less premium amortization amortizatio n for 2005 (see no. 2) Carrying amount, 12/31/2005

3,077 P2,036,923

Question No. 4 Face value of bonds retired

P1,000,000

Add unamortized bond premium, (P40,000 x ½ x 57/117)

9,744

Carrying amount of bonds retired

1,009,744

Less retirement price (P1,000,000 x .99) Gain on bond reacquisition

990,000 P

19,744

Question No. 5 Face value of bonds retired

P1,000,000

Add unamortized bond premium, (P40,000 x ½ x 54/117)

9,231

Carrying amount of bonds retired

1,009,231

Less retirement price (P1,000,000 x .97) Gain on bond reacquisition

970,000 P

39,231

 Bonds payable PROBLEM NO. 8 –  Bonds In your initial audit of Infanta Finance Co., you find the following ledger account balances. Debit

Credit

12%,25-year Bonds Payable, 2006 issue 01/01/2006

P6,400,000

Treasury Bonds 10/01/2010

P864,000

Bond Premium 01/01/2006

320,000

Bond Interest Expense 01/01/2010

384,000

07/01/2010

384,000

The bonds were redeemed for permanent cancellation on October 1, 2010 at 105 plus accrued interest. QUESTIONS: Based on the above and the result of your audit, determine the following: ( Use straight line method to amortize premium or discount) a.  b. a.  b. a.  b. a.  b.

1. The adjusted balance of bonds payable as of December 31, 2010 is P5,536,000 c. P5,600,000 P6,400,000 d. P4,000,000 2. The unamortized bond premium on December 31, 2010 is P320,000 c. P256,000 P224,000 d. P235,200 3. The total bond interest expense for the year 2010 is P756,400 c. P731,600 P755,200 d. P731,200 4. The gain or loss on partial bond redemption is P7,600 loss c. P7,600 gain P72,400 loss d. P72,400 gain

 Answers: 1)C; 2)B; 3)C; 4)A Suggested Solution: Question No. 1 Total bonds issued Face value of bonds retired

P6,400,000

{P864,000/[1.05+(.12x3/12)]} {P864,000/[1.05+(.12x3/12)]}

800,000

Adjusted balance of bonds payable, 12/31/10

P5,600,000

Question No. 2 Unamortized bond premium, 12/31/10 (P320,000 x 8/64 x 20/25)

P224,000

Question No. 3  Nominal interest: interest: Remaining bonds (P5,600,000 x 12%)

P672,000

Bonds retired (P800,000 x 12% x 9/12)

72,000

P744,000

Less premium amortization: Remaining bonds (P320,000/25 (P320,000/2 5 x 14/16

11,200

Bonds retired (P320,000/25 x 2/16 x 9/12)

1,200

12,400 P731,600

Question No. 4 Face value of bonds redeemed

P800,000

Unamortized bond premium (P320,000 x 8/64 x 20.25/25)

32,400

Carrying amount of bonds redeemed

832,400

Less retirement retirement price (P800,000 x 1.05)

840,000

Loss on bond redemption

P 7,600

 Bonds payable payable PROBLEM NO. 9 –  Bonds In connection with the audit of the company’s financial statements for the year ended December 31, 2010, the Lucban Corporation presented to you their records. This is the first time the company has been audited. The company issued serial bonds on April 1, 2007. Your audit showed the following details of the issue and the accounts as of December 31, 2010: Total face value

P2,000,000

Date of bond

March 1, 2007

Total proceeds

P2,676,000

Interest rate

12% per annum

Interest payment date

March 1

Maturity dates and amount: Date of maturity

Amount

March 1, 2010

P 500,000

March 1, 2011

P 500,000

March 1, 2012

P 500,000

March 1, 2013

P 500,000 P2,000,000

Since the corporation had excess cash, bonds of P500,000 schedule to be retired on March 1, 2012 were retired on April 1, 2010. The total amount paid was charged to serial bonds payable amount. Serial Bonds Payable 3/01/2010

VR

P500,000

4/01/2010

VR

P495,000

4/01/2007

CR

P2,656,000

GJ

P200,000

Accrued Interest Payable 01/01/2010

Interest Expense 3/01/2010

VR

P240,000

QUESTIONS: Based on the information presented above and the result of your audit, answer the following: ( Use bond outstanding method to amortize premium or discount) 1. The adjusted balance of the bonds payable account as of December 31, 2010 is a. P2,000,000 c. P1,500,000  b. P1,084,000 d. P1,000,000 2. The unamortized bond premium as of December 31, 2010 should be a. P66,642 c. P84,000  b. P82,444 d. P104,000 3. The accrued interest payable as of December 31, 2010 is

a. P150,000  b. P120,000

c. P100,000 d. P200,000

4. The bond interest expenses that should be reported by the corporation for the year 2010 is a. P55,264  b. P53,000 5. The gain on early retirement of bonds is a. P79,000  b. P77,722

c. P63, 801 d. P59,611 c. P81,170 d. P 0

 Answers: 1) D; 2) C; 3) C; 4) B; 5) A Suggested Solution: Question No. 1 Total bonds issued

P2,000,000

Bonds retired, 3/1/10

(500,000)

Bonds retired, 4/1/10

(500,000)

Adjusted balance of bonds payable, 12/31/10

P1,000,000

Question No. 2 Total proceeds

P2,656,000

Less accrued interest payable (P2,000,000 x 12% x 1/12)

20,000

Issue price

2,636,000

Less face value

2,000,000

Total bond premium

636,000

Less: Amortization: Prior years (2007 to 2009)

P396,000

Current year (2010) Bonds retired on maturity (P500,000 x .006 x 2mos.)

P6,000

Bonds retired prior to maturity (P500,000 x .006 x 3 mos.)

9,000

Remaining bonds (P1M x .006 x 3 mos.)

72,000

87,000

483,000

Unamortized premium Cancelled on bonds retired Prior to maturity (P500,000 x .006 x 23 mos)

69,000

Unamortized bond premium, 12/31/10 12/31/1 0

P84,000

Computation of amortization rate: Year

Period Covered

Bond outs.

Mos.

Peso months

Premium amort*

2007

04/01-12/31

P2,000,000

9

P18,000,000

P108,000

2008

01/01/-12/31

2,000,000

12

24,000,000

144,000

2009

01/01-12/31

2,000,000

12

24,000,000

144,000

2010

01/01-02/28

2,000,000

2

4,000,000

24,000

03/01-12/31

1,500,000

10

15,000,000

90,000

01/01-02/28

1,500,000

2

3,000,000

18,000

03/01-12/31

1,000,000

10

10,000,000

60,000

01/01-02/28

1,000,000

2

2,000,000

12,000

03/01-12/31

500,000

10

5,000,000

30,000

01/01-02/28

500,000

2

1,000,000

6,000

2011

2012

2013

P106,000,000 P636,000  Amortization rate = P636,000/P106,0 P636,000/P106,000,000 00,000 = .006 .006 * Peso months x .006

Question No. 3 Accrued interest payable, 12/31/10 (P1,000,000 x 12% x 10/12)

Question No. 4  Nominal interest: interest:

P100,000

Remaining Remaining bonds (P1,000,000 x 12%)

P120,000

Bonds retired on maturity (P500,000 x 12% x 2/12

10,000

Bonds retired prior to maturity (P500,000 x 12% x 3/12)

15,000 145,000

Less premium amortization amortizatio n for 2010 (see no. 2) Interest expense for 2010

87,000 P 58,000

Question No. 5 Face value Add unamortized bond premium, (P500,000 x .006 x 23 mos.)

P500,000 69,000

Carrying amount of bonds retired

569,000

Less retirement price (P500,000 x .98)

490,000

Gain on early retirement retirement of bonds

P 79,000

 Bonds Payable Payable PROBLEM NO. 10 –  Bonds On January 1, 2009, Perez Corporation issued 5,000 of its 5-year, P1,000 face value, 11% bonds dated January 1 at an effective annual interest rate (yield) of 9%. Interest is payable each December 31. Perez uses the effective interest method of amortization. On December 31, 2010, the 3,000 bonds were extinguished early through acquisition in the open market by Perez for P2,970,000 plus accrued interest. QUESTIONS: Based on the above and the result of your audit, determine the following: ( Round ( Round off present present value factors to four decimal places.) 1. The issue price of the bonds on January 1, 2009 is a. P5,388,835 c. P5,282,135  b. P4,630,655 d. P5,000,000 2. The carrying amount of the bonds on December 31, 2009 is a. P4,755,930 c. P5,323,830  b. P5,453,840 d. P5,000,000 3. The gain on early retirement of bonds on December 31, 2010 is a. P116,442 c. P181,785  b. P266,811 d. P 0  Answers: 1) A; 2) C; 3) C Suggested Solution: Question No. 1

PV of principal (P5,000,000 x 0.6499)

P3,249,500

PV of interest ([(P5,000,000 ([(P5,000,000 x 11%) x 3.8897] Issue price

2,139,335 P5,388,835

Question No. 2 Carrying amount, 1/1/06

P5,388,835

Less premium amortization for 2009:  Nominal interest interest (P5M (P5M x 11%) Effective interest (P5,388,835 x 9%) Carrying amount, 12/31/09

P550,000 484,995

65,005 P5,323,830

 Alternative  Alternative Computation: Computation: PV of principal (P5M x 0.7084)

P3,542,000*

PV of interest [(P5M x 11%) x 3.2397]

1,781,835

Carrying amount, 12/31/09

P5,323,835

* P5 difference due to rounding off. Question No. 3 Carrying amount, 1/1/09 (see no. 2)

P5,323,830

Less premium amortization for 2009:  Nominal interest interest (P5M (P5M x 11%) Effective interest (P5,323,830 (P5,323,830 x 9%)

P550,000 479,145

70,855

Carrying amount, 12/31/10

P5,252,975

Carrying amount of bonds retired (P5,394,685 x 3/5

P3,151,785

Less retirement price Gain early retirement of bonds

2,970,000 P 181,785

PROBLEM NO. 11  –  Convertible bonds payable

On January 2, 2009, the Mauban Inc. issued P2,000,000 of 8% convertible bonds at par. The  bonds will mature on January 1, 2013 and interest is payable payable annually every January January 1. The The bond contract entitles the bondholders to receive 6, P100 par value, ordinary shares in exchange for each P1,000 bond. On the date of issue, the prevailing market interest rate for similar debt without the conversion option is 10%.

On January 1, 2013, the holders of the bonds with total face value of P1,000,000 exercised exercised their conversion privilege. On that date, the bonds were selling at 110 and the ordinary share at P42. QUESTIONS: Based on the above and the result of your audit, answer the following: (Round off present value  factors to 4 decimal places) 1. The proceeds from issuance of convertible bonds to be allocated to the liability component is a. P1,366,000 c. P1,873,184  b. P1,778,336 d. P2,000,000 2. The proceeds from issuance of convertible bonds to be allocated to the equity component is a. P634,000 c. P126,816  b. P221,664 d. P 0 3. The carrying amount of the bonds payable on December 31, 2009 is a. P2,000,000 c. P1,389,400  b. P1,796,170 d. P1,900,502 4. The interest expense for the year 2010 is a. P160,000 c. P138,940  b. P179,617 d. P190,050 5. The gain to be recognized on conversion of the bonds is a. P126,816 c. P463,408  b. P400,000 d. P 0

 Answers: 1) C; 2) C; 3) D; 4) D; 5) D

Suggested Solution: Question No. 1 PV of principal (P2,000,000 x 0.6830) PV of interest [(P2,000,000 x 8%) x 3.1699] Liability component

P1,366,000 507,184 P1,873,184

 PAS 32 par. 29 states that an entity entity recognized recognized separately separately the the components components of a financial instrument that (a) creates a financial liability of the entity and (b) grants an option to the holder of the instrument to convert it into an equity instrument of the entity. Par. 31 further states that equity instruments are instruments that evidence a residual interest in the assets of an entity after deducting all of its liabilities. Therefore, when an initial carrying amount of a compound  financial instrument is allocated to its equity equity and liability liability components, components, the the equity component is is assigned the residual amount after deducting from the fair value of the instrument as a whole the amount separately determined for the liability component. Question No. 2 Total proceeds

P2,000,000

Less liability component (see no. 1)

1,873,184

Equity component

P

126,816

 Incidentally,  Incidentally, the journal journal entry entry to record record the issuance issuance of the convertible convertible bonds bonds follow: Cash

P2,000,000

Discount on bonds payable

126,816

Bonds payable

P2,000,000

Share premium –  premium – conversion conversion option

126,816

Question No. 3 Carrying amount, 1/2/09 (see no. 1)

P1,873,184

Add: Discount amortization for 2006: Effective interest (P1,873,184 x 10%)  Nominal interest interest (P2,000,000 (P2,000,000 x 8 %)

P187,318 160,000

Carrying amount, 12/31/09

27,318 P1,900,502

Question No. 4 Effective interest (P1,900,502 x 10%)

P190,050

Question No. 5 On conversion of a convertible instrument at maturity, the entity derecognizes the liability component and recognized it as equity. The original equity component remains as equity  gain or or (although it may be transferred from one line item within equity to another). There is no  gain loss on conversion at maturity. (PAS 32 AG32) Journal entry to record the conversion (no transfer) Bonds Payable

P1,000,000

Share Capital (P1,000,000/P1,000 (P1,000,00 0/P1,000 x 6 x P100)

P600,000

Share Premium –  Premium – excess excess over par

400,000

Journal entry to record the conversion (with transfer) Bonds Payable Share Premium –  Premium – conversion conversion option (P126,816 x ½) Share Capital (P1,000,000/P1,000 (P1,000,00 0/P1,000 x 6 x P100)

P1,000,000 63,408 P600,000

Share Premium –  Premium – excess excess over par

463,408

The accounting for convertible bonds is similar in nature with accounting for bonds issued with detachable warrants. Therefore, although both journal entries will have the same net effect on equity, the second journal entry is preferable to be consistent with accounting for bonds with detachable warrants.

PROBLEM NO. 12 – Convertible  – Convertible bonds payable

On January 1, 2005, Calauag Corporation issued a 10 per cent convertible bonds with a face value of P4,000,000 maturing on December 31, 2014. Each P1,000 bond is convertible into ordinary shares of Calauag at a conversion price of P25 per share. Interest is payable half-yearly in cash. At the date of issue, Calauag could have issued nonconvertible debt with a ten-year term bearing a coupon interest rate of 11 per cent. On January 1, 2010, the convertible bond has a fair value of P4,400,000. Calauag makes a tender offer to the holders to repurchase the bonds for P4,400,00. The holders of the P2,000,000 bonds accepted the offer. At the fate of repurchase, Calauag could have issued non-convertible debt with a five-year term bearing a coupon interest rate of 8 per cent. On December 31, 2010, to induce the holders of the remaining bonds to convert the bonds  promptly, Calauag reduces the conversion conversion price to P20 if the bonds are converted before March March 1, 2011 (ie within 2 months). The market price of Calauag’s or dinary or dinary shares on the date the terms are amended is P32 per share. QUESTIONS: Based on the above and the result of your audit, answer the following: ( Round  Round off present present value value factors factors to 4 decimal decimal places) places) 1. The proceeds from issuance of convertible bonds to be allocated to the equity component is a. P235,520 c. P136,760  b. P239,120 d. P 0 2. The carrying amount of the bonds on December 31, 2009 is a. P3,849,120 c. P3,113,180  b. P3,885,940 d. P4,000,000 3. The amount to be recognized recognized in profit or loss as a result of the repurchase of the bonds on January 1, 2010 is a. P200,000 c. P180,400  b. P203,880 d. P237,730 4. The repurchase of the bonds on January 1, 2010 decreased equity by a. P439,530 c. P76,630  b. P 37,710 d. P 0 5. The amount to be recognized in profit or loss as a result of the amendment of the terms on December 31, 2010 is a. P640,000 c. P64,000  b. P 10,000 d. P 0  Answers: 1)B; 2) A; 3)D; 4)B; 5)A

Suggested Solution: Question No. 1 Issue Price

P4,000,000

Less Liability component: PV of principal (P4,000,000 x 0.3427) PV of interest [(P4,000,000 [(P4,000,00 0 x 5%) x 11.9504]

P1,370,800 2,390,080

Equity Component

3,760,000 P 239,120

Question No. 2 PV of principal (P4,000,000 x 0.5854)

P2,341,600

PV of interest [(P4,000,000 [(P4,000,000 x 5%) x 7.5376]

1,507,520

Carrying amount, 12/31/09

P3,849,120

Question No. 3 Carrying amount of bonds retired (P3,849,120 (P3,849,1 20 x ½)

P1,924,560

Less payment applied to liability component: PV of principal (P2,000,000 x 0.6756) PV of interest [(P2,000,000 x 5%) x 8.1109] Loss on repurchase of bonds

P1,351,200 811,090

2,162,290 P

237,730

When an entity extinguishes a convertible instrument before maturity through an early redemption or repurchase in which the original conversion privileges are unchanged, the entity allocates the consideration paid and any transaction costs for the repurchase or redemption to the liability and equity components of the instrument at the date of the transaction. The method used in allocating the consideration paid and transaction costs to the separate components is consistent with that used in the original allocation to the separate components of the proceeds received by the entity when the convertible instrument was issued. ( PAS ( PAS 32 AG33) Once the allocation of the consideration is made, any resulting gain of loss is treated in accordance with accounting principles applicable to the related component, as follows: (a) The amount of gain or loss relating to the liability component is recognized in profit or loss; and  (b) The amount of consideration relating to the equity component is recognized in equity. ( PAS ( PAS AG34)

Question No. 4 Retirement price (P4,4400,000 x ½)

P2,200,000

Less payment applied to liability component Payment allocated to equity component

2,162,290 P

37,710

Question No. 5 Ordinary shares to issued –  issued – amended amended terms (P2,000,000/P20) (P2,000,0 00/P20)

100,000

Ordinary shares to issued –  issued – original original terms (P2,000,000/P25 (P2,000,000/P25

80,000

Incremental ordinary shares to be issued

20,000

Value of incremental shares to be issued (P20,000 x P32)

P640,000

 An entity may amend the terms terms of a convertible convertible instrument instrument to induce early early conversion, conversion, for example by offering a more favorable conversion ratio or paying other additional consideration in the event of conversion before a specified date. The difference, at the date the terms are amended, between the fair value of the consideration the holder receives on conversion of the instrument under the revised terms and the fair value of the consideration the holder would have received under the original terms is recognized as a loss in profit or loss. ( PAS ( PAS 32 AG35)

 – Comprehensive PROBLEM NO. 13 – Comprehensive In connection with your audit of Pagbilao Corporation, you gathered the following liability and equity account balances as of December 31, 2009: 1% bonds payable, at face value Premium on bonds payable Share Capital

P10,000,000 704,760 16,000,000

Share Premium

4,590,000

Retained Earnings

4,930,000

Treasury shares, at cost

650,000

Transactions during 2010 and other information relating to the Corporation’s liability and equity a ccounts were as follows: a) The bonds were issued on December 31, 2007, for P10,756,000 to yield 10%. The bonds mature on Deecember 31, 2022. Interest in payable annually on December 31. The Corporation used the effective interest method to amortize bond premium.  b) At December 31, 2009, the Corporation had 4,000,000, P10 par, authorized ordinary shares.

c) On January 15, 2010, the Corporation reissued 30,000 of its 50,000 treasury shares for 550,000. The treasury shares had been acquired on February 28, 2009. d) On November 2, 2010, the Cooperation borrowed P8,000,000 at 9% evidenced by a note payable to ABC Bank. The note is payable in five equal annual principal installments of P1,600,000. The first  principal and interest interest payment payment is due on November November 2, 2011. e) On December 31, 2010, the Corporation owned 20,000 ordinary shares of Awoo Corp. which represented a 1% ownership interest. Pagbilao accounts for this as availale for sale securities. The shares were purchased on May 4, 2009 at P20 per share. The market price was P21 per share on December 31, 2009, and P18 per share on December 31, 2010. QUESTIONS: Based on the above and the results of your audit, answer the following questions: 1. How much is the carrying of the bonds payable on December 31, 2010? a. P10,675,236 c. P 9,324,764  b. P10,706,760 d. P10,654,360 2. How much is the treasury shares balance as of December 31, 2010? a. P200,000 c. P260,000  b. P650,000 d. P100,000 3. How much is the noncurrent portion of the note payable to bank as of December 31, 2010? a. P6,400,000 c. P8,000,000  b. P1,600,000 d. P 0 4. How much is the 2010 total interest expense? a. P1,220,000 c. P1,249,524  b. P1,190,476 d. P1,187,236 5. How much is the net unrealized loss on available for sale securities as of December 31, 2010? a. P60,000 c. P20,000  b. P40,000 d. P 0  Answers: 1)A; 2)C; 3)A; 4)B; 5)B

Suggested Solution: Question No. 1 Carrying amount, 12/31/09 (P10,000,000 (P10,000,00 0 + P704,760)

P10,704,760

Less premium amortization for 2010:  Nominal interest interest (P10,000,000 (P10,000,000 x 11%) 11%)

P1,100,000

Effective interest (P10,704,760 x 10%)

1,070,476

Carrying amount, 12/31/10

29,524 P10,675,236

Question No. 2 Treasury shares, 12/31/09

P650,000

Less cost of treasury shares issued (P650,000 x 3/5) Treasury shares, 12/31/10

390,000 P260,000

Question No. 3 Total face value Less principal installment installment due, 11/1/11  Noncurrent portion portion

P8,000,000 1,600,000 P6,400,000

Question No. 4 On note payable (8,000,000 x 9% x 2/12) On bonds payable (see no. 1) Total interest expense

P

120,000 1,070,476

P 1,190,476

Question No. 5 Cost (20,000 x P20)

P400,000

Market value (20,000 x P18)

360,000

 Net unrealized unrealized loss, 12/31/10

P 40,000

PROBLEM NO. 14 – Comprehensive  – Comprehensive

The noncurrent liabilities liabilities of Pitogo Company at December December 31, 2009 included the following: following:  Note Payable, Payable, bank

P3,600,000

Liability under finance lease

2,623,000

 Note payable, payable, supplier supplier

1,500,000

Transactions Transactions during 2010 and other information relating relating to Pitogo’s liabilities were as follows: a) The note payable to the bank bears interest at 20% and is dated May 1,2009. The principal amount of P3,600,000 is payable in four equal annual installments of P900,000 beginning May 1, 2010. The first principal and interest payment was made on May 1, 2010.  b) The finance lease is for a ten-year period. Equal annual payments of P750,000 are due on December 31, of each year. The interest rate implicit in the lease is 18%. The amount of P2,623,200 represents the present value of the six remaining lease payments (due December 31, 2010 through December 31, 2015) discounted at 18%. c) The note payable to supplier bears interest at 19% and matures on September 30, 2011. On February 25, 2011, after the end of of the reporting period, but before the 2010 statements statements were

authorized for issue, Pitogo Company consummated consummated a noncancelable noncancelable agreement with a lender to refinance the 19%. P1,500,000 on a long term basis, on readily determinable terms that have not yet been implemented. Both parties are financially capable of honoring the agreement, and there have been no violations of the agreement’s provisions. d) On April 1, 2010, Pitogo issued for P7,005,675, P6,000,000 face amount of its 20%, P100,000  bonds. The bonds were issued to yield yield 15%. The bonds are dated April 1, 2010 2010 and mature mature on April 1, 2015. Interest is payable annually on April 1. QUESTIONS: Based on the above and the result of your audit, determine the following: 1. Liability under finance lease as of December 31, 2010 a. P1,873,200 c. P2,017,544  b. P2,345,376 d. P1,123,200 2. Carrying amount of bonds payable as of December 31, 2010 a. P6,893,813 c. P6,856,527  b. P7,417,536 d. P7,117,536 3. Total noncurrent liabilities as of December 31, 2010 a. P12,211,357 P12,211,35 7 c. P10,711,357  b. P10,154,190 P10,154,19 0 d. P 9,817,014 4. Current portion of long-term liabilities as of December 31, 2010 a. P3,150,000 c. P2,727,832  b. P2,812,824 d. P2,169,864 5. Total interest expense for the year 2010 a. P2,145,314 c. P1,673,139  b. P2,408,028 d. P1,673,139 Answers: 1)B; 2)A; 3)C; 4)C; 5)A

Suggested Solution: Question No. 1 Liability under finance lease 1/1/10

P2,623,200

Less principal payment on 12/31/10 Total payment Less applicable applicable to interest (P2,623,200 x 18%) Liability under finance lease, 12/31/10

P750,000 472,176

277,824 P2,345,376

Question No. 2 Carrying amount, 4/1/10 Less premium amortization:

P7,005,675

Nominal interest (P6,000,000 x 20% x 9/12)

P900,000

Effective interest (P7,005,675 x 15% x 9/12)

788,138

Carrying amount, 12/31/10

111,862 P6,893,813

Question No. 3 20% Note payable, bank Balance, 12/31/10 (P3,600,000 –  (P3,600,000  – P900,000) P900,000)

2,700,000

Less installment installment due, 4/1/11

900,000

P1,800,000

Liability under finance lease: Balance, 12/31/10 (see no. 1)

2,345,376

Less principal payment due on 12/31/11 Total payment

750,000

Less applicable to interest (P2,345,376 x 18%)

422,168

327,832

2,017,544

20% bonds payable due 4/1/15 (see no. 2)

6,893,544

Total noncurrent liabilities, 12/31/10

P10,711,357

Question No. 4 20% note payable, bank - due 4/1/10 Finance lease liability –  liability  – principal principal payment due on 12/31/10 (see no.3) 19% Note payable, bank –  bank  – due due 9/30/10 Current portion of long-term liabilities, ,12/31/09

P900,000 327,832 1,500,000 P2,727,832

The Note payable to supplier was classified as current liability since it is due within 12 months after the reporting period and the entity does not have an unconditional right to defer settlement of the liability for at least 12 months after the reporting period (even if an agreement to refinance on a long term basis is completed after the end of the reporting period an before the financial statements are authorized for issue  –  such  such an agreement would qualify for disclosure as a non-adjusting event in accordance with PAS 10).

Question No. 5 20% Note payable, bank

1/1 to 4/30 (P3,600,000 x 20% x 4/12) 5/1 to 12/31 (P2,700,000 x 20% x 8/12)

P240,000 360,000

P 600,000

Liability under finance lease (see no. 1)

472,176

20% bonds payable (see no. 2)

788,138

19% note payable, bank (P1,500,000 x 19%)

285,000

Total interest expense in 2010

P2,145,314

PROBLEM NO. 15 –  Finance  Finance lease –  lease –  Direct  Direct financing

Luna Corporation is in the business of leasing new sophisticated computer systems. As a lessor of computers, Luna purchased a new system on December 31, 2009. The system was delivered the same day (by prior arrangement) to General Investment Company, a lessee. The corporation accountant revealed the following information relating to the lease transaction: transaction: Cost of system to Luna

P550,000

Estimated useful life and lease term

8 years

Expected residual value (unguaranteed) (unguaranteed)

P40,000

Luna’s Luna’s implicit rate of interest

12%

General’s incremental borrowing rate  rate 

14%

Date of first lease payment

December 31, 2009

Additional information is as follows: (a) At the end of the lease, the system will revert to Luna. (b) General is aware of Luna’s ra te of implicit interest. (c) The lease rental consists of equal annual payments. QUESTIONS: Based on the above and the result of your audit, answer the following: ( Round ( Round off present value value factors factors to  four decimal decimal places.) places.) 1. The annual lease payment under the lease is a. P110,717 c. P102,665  b. P95,950 d. P91,664 2. The total financial revenue to be earned by the lessor over the lease a. P257,600 c. P271,320  b. P52,714 d. P335,736 3. The interest income to be recognized by the lessor in 2010 is a. P53,680 c. P54,486  b. P52,714 d. P52,547 4. The total expenses related to the lease that will be recognized by the lessee in 2010 is a. P121,464 c. P112,630

 b. P130,792 d. P119,276 5. The amount to be reported under current liabilities as liability under finance lease as of December 31, 2010 is a. P60,239 c. P35,715  b. P48,611 d. P64,963

 Answers: 1)B; 2)A; 3)C; 4)D; 5)B Suggested Solution: Question No. 1 Cost of system

P550,000

Less present value of unguaranteed residual value (P40,000 x 0.4039)

16,156

 Net investment investment to be recovered

533,844

Divide by the present value of annuity due of P1 at 12% for 8 periods Annual lease payment

5.5638 P 95,950

Question No. 2 Gross investment in the lease: Minimum lease payments (P95,950 x 8) Unguaranteed residual value

P767,600 40,000

P807,600

 Net investment investment in the lease: PV of minimum lease payments PV of unguaranteed residual value Total unearned interest income

533,844 16,156

550,000 P257,600

 A lease is classified as a finance finance lease if it transfers transfers substantially substantially all all the risks risks and rewards rewards incidental incidental to ownership. A lease is classified as an operating lease if it does not transfer substantially all the risks and rewards incidental to ownership. ( PAS PAS 17 par. 8) Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the form. Situations that would normally lead to a lease being classified as a finance lease include the following:  

The lease transfers ownership of the asset to the lessee by the end of the lease term; The lessee has the option to purchase the asset at a price which is expected to be sufficiently lower than fair value at the date the option becomes exercisable that, at the inception of the lease, it is reasonably certain that the option will be exercised;







The lease term is for the major part of the economic life of the asset, even if title is not transferred;  At the inception inception of the lease, lease, the preset preset value of the minimum minimum lease payments amounts amounts to at least least  substantially all of the fair value of the leased leased asset; and The lease assets are of a specialized nature such that only the lessee can use them without major modifications being made. ( PAS PAS 17 par. 10)

 PAS 17 par. 4 defines defines unearned finance income income as the difference between: between: (a) The gross investment in the lease and (b) The net investment in the lease Gross investment in the lease is the aggregate of: (a) The minimum lease payments receivable by the lessor under a finance lease, and (b)  Any unguaranteed unguaranteed residual residual value accruing to the lessor. lessor.  Net investment investment in the lease is the gross gross investment investment in the the lease discounted discounted at the interest interest rate implicit in the lease.

Question No. 3 Interest income in 2010 [(P550,000 –  [(P550,000  – 95,950) 95,950) x 12%]

P54,486

The following principles should be applied in the financial statements of lessors: 





 At commencement commencement of the lease term, the the lessor should should record record a finance finance lease in the statement statement of financial position as a receivable, at an amount equal to the net investment in the lease; The lessor should recognize finance income based on a pattern reflecting a constant periodic rate of return on the lessor’s net investment outstanding outstanding in respect of the finance lease; and   For operating leases, the lease payment should be recognized recognized as an expense expense in the the income  statement over over the lease term term on a straight-line straight-line basis, basis, unless unless another systematic systematic basis basis is more more representative of the time pattern of the user’s benefit.

Question No. 4 Interest expense [(P533,844 –  [(P533,844 – P95,950) P95,950) x 12%] Depreciation expense (P533,844/8) (P533,844/ 8) Total

P 52,547 66,731 P119,278

The following principles should be applied in the financial statements of lessees: 

 At commencement commencement of the lease term, finance finance leases leases should be recorded recorded as an asset and a liability at the lower of the fair value of the asset and the present value of the minimum lease payments (discounted at the interest rate implicit in the lease, if practicable, or else at the entity’s incremental incremental borrowing rate);







 Finance lease lease payments should should be apportioned between the finance charge and the reduction reduction of the outstanding liability (the finance charge to be allocated so as to produce a constant periodic rate of interest on the remaining balance of the liability); The depreciation policy for assets held under finance leases should be consistent with that for owned assets. If there is no reasonable certainty that the lessee will obtain ownership at the nd of the lease –  lease –  the  the asset should be depreciated over the shorter of the lease term or the life of the asset; and  For operating operating leases, the lease payments should be recognize recognized d as an expense expense in profit or loss loss over the lease term on a straight-line basis, unless another systematic basis is more representative of the time pattern of the user’s benefit.

Question No. 5 Finance lease liability, 13/31/09

P533,844

Less lease payment, 12/31/09

95,950

Balance, 12/31/09

437,894

Less principal payment on 12/31/10; Total payment in 2010 Less applicable applicable to interest (P437,894 x 12%)

P95,950 52,547

43,404

Balance, 12/31/10

P394,491

Total payment in 2011

P95,950

Less applicable applicable to interest (P394,491 x 12%) Current portion of finance lease liability

47,339 P48,611

PROBLEM NO. 16 –  Finance  Finance lease –  lease –  direct  direct financing

In connection with your audit Nakar Enterprises, you noted that the company has a long-standing  policy of acquiring acquiring company company equipment equipment by leasing. Early in 2010, 2010, the company company entered entered into a lease for a new milling machine. The lease stipulates that annual payments will be made for 5 years. The  payments are to be made in advance on December December 31 of each each year. At the end end of the 5-year period,  Nakar may may purchase the machine. machine. The estimated estimated economic economic life of the the equipment equipment is 12 years. years. Nakar Nakar uses the calendar year for reporting pusposes and straight-line depreciation for other equipment. In addition, the following information about the lease is also available: Annual lease payments (including executory costs of P5,000)

P60,000

Purchase option price

P25,000

Estimated fair value of machine after 5 years

P75,000

Implicit rate Date of first lease payment

10% Jan. 1, 2010

QUESTIONS: Based on the foregoing and the result of your audit, compute for the following: ( Round ( Round off present present value factors to four decimal places.) 1. Amount to be capitalized as an asset for the lease of the milling machine. a. P229,345 c. P244,868  b. P224,017 d. P275,913 2. Liability under finance lease as of December 31, 2010 a. P130,919 c. P136,780  b. P153,855 d. P189,868 3. Amount to be reported under current liabilities as liability under finance lease as of December 31, 2010 a. P39,614 c. P41,908  b. P41,322 d. P36,013 4. Interest expense for the year 2010 a. P17,435 c. P16,902  b. P18,987 d. P 0 5. Depreciation expense for the year 2010 a. P20,406 c. P18,668  b. P19,112 d. P48,974 Answers: 1)C; 2)B; 3)A; 4)B; 5)A Suggested solution: Question No. 1 PV of rental payments (P55,000 x 4.1669) PV of purchase option (P25,000 x 0.x6209) PV of MLP (Cost of asset)

P229,345 15,523 P244,868

 At the commencemen commencementt of the lease term, term, a lessee lessee shall recognize recognize finance finance leases leases as assets assets and liabilities liabilities in its statement of financial position at amounts equal to the fair value of the leased property or, if lower, the  present value value pf the the minimum lease payments, payments, each each determined determined at the inception inception of the lease. The The discount discount rate to be used in calculating the present value of the minimum lease payments is the interest rate implicit in the lease, if this is p racticable to determine; if not, the lessee’s incremental incremental borrowing rate shall be used. ( PAS PAS 17 par. 20)  Minimum lease lease payments payments are payment payment over the the lease term that the lessee lessee is or can can be required required to make, make, excluding contingent rent, costs for services and taxes to be paid by and reimbursed to the lessor, together with: (a)  For a lessee, lessee, any amounts guaranteed guaranteed by the lessee lessee or by a party related related to the the lessee; lessee; or (b)  For a lessor, lessor, any residual residual value value guaranteed guaranteed to the lessor by: by:

i. ii. iii.

The lessee;  A party related related to the the lessee; lessee; or  A third party party unrelated unrelated to the lessor that that is financially financially capable capable of discharging discharging the the obligation under the guarantee.

 However, if the lessee lessee has an an option to purchase purchase the the asset at at a price that is expected expected to be sufficiently sufficiently lower than the fair value at the date the option becomes exercisable for it to be reasonably certain, at the inception of the lease, that the option will be exercised, the minimum lease payments comprise the minimum payments payable over the lease term to the expected date of exercise of this purchase option and the payment required to exercise it. Question No. 2 Finance lease liability, 1/1/10

P244,868

Less lease payment, 1/1/10

55,000

Balance, 1/1/10

189,868

Less principal payment on 12/31/10: Total payment in 2010 Less applicable to interest (P189,868 x 10%) Balance, 12/31/10

P55,000 18,987

36,013 P153,855

Question No. 3 Rental payment in 2011 Less applicable applicable to interest (P153,855 x 10%) Current portion of finance lease liability

P55,000 15,386 P39,614

Question No. 4 Interest Expense in 2010 (see no. 2)

P18,987

Question No. 5 Depreciation expense in 2010 (P244,868 / 12)

P20,406

 Finance lease –  lease –  Sales  Sales type PROBLEM NO. 17 –  Finance Catanauan Incorporated uses leases as a method of selling its products. In early 2009, Catanauan completed construction of a passenger ferry for use between Quiapo and Guadalupe. On April 1, 2009, the ferry was leased to the Balik-Balik Ferry line on a contract specifying that ownership of the ferry will transfer to the lessee at the end of the lease period. The ferry is expected to be economically useful for 25

years. Annual lease payments do not include executory costs. Other terms of the agreement are as follows: Original cost of the ferry

P1,500,000

Lease payments

P 225,000

Estimated residual value

P

78,000

Implicit rate

10%

Date of first lease payment

April 1, 2009

Lease period

1 year

PV of an ordinary annuity of 1 for 20 periods 10%

8.5136

PV of an annuity due of 1 for 20 periods at 10%

9.3649

PV of 1 for 20 periods at 10%

0.1486

QUESTIONS: Based on the above and the result of your audit, determine the following: 1. Total finance income that will be earned by the lessor over the lease term. a. P2,459,306 c. P2,392,897  b. P2,650,849 d. P2,584,440 2. The profit on sale to be recognized by the lessor a. P607,103 c. P415,560  b. P427,151 d. P618,694 3. Liability under finance lease to be reported by the lease as of December 31, 2010 a. P1,634,616 c. P1,858,063  b. P1,845,313 d. P1,647,366 4. Amount to be reported under current liabilities as liability under finance lease by the lessee as of December 31, 2010 a. P61,538 c. P40,469  b. P39,194 d. P60,263 5. Depreciation expense to be recognized by the lessee for the year 2009 a. P61,221 c. P76,091  b. P55,127 d. P60,873 Answers: 1)C; 2)A; 3)B; 4)C; 5)D

Suggested Solution: Question No. 1 Gross investment in the lease (P225,000 x 20)  Net investment investment in the lease (P225,000 x 9.3649)

P4,500,000 2,107,103

Total finance income

P2,392,103

The unguaranteed residual value was not included in the computation of the minimum lease payments  since the leased asset asset will be not revert revert to the lessor.

Question No. 2 Sales (PV of MLP) Less cost of sales Profit on sale

P2,107,103 1,500,000 P 607,103

Question No. 3 Finance lease liability, 4/1/09

P2,107,103

Less lease payment, 4/1/09

225,000

Balance, 4/1/09

1,882,103

Less principal payment on 4/1/10: Total payment in 2010 Less applicable applicable to interest (P1,882,103 x 10%)

P225,000 188,210

Balance, 12/31/10

36,790 P1,845,313

Question No. 4 Rental payment in 2011 Less applicable to interest (P1,845,313 (P1,845,31 3 x 10%) Current portion of finance lease liability

P250,000 184,531 P 40,469

Question No. 5 Depreciation expense in 2009 [(P2,107,103 –  [(P2,107,103  – P78,000) P78,000) x 1/25 x 9/12]

P60,873

 Finance lease –  lease –  Sales  Sales type PROBLEM NO. 18 –  Finance Real Inc. leases equipment to its customers under noncancelable leases. On January 1, 2010.Real leased equipment costing P4,000,000 to Quezon Co., for nine years. The rental cost was P440,000  payable in advance semiannually (January 1 and July 1), plus P20,000 semiannually for executory costs. The equipment had an estimated life of 15 years and sold for P5,330,250 with an estimated unguaranteed residual value of P800,000. The implicit interest rate is 12 percent.

QUESTIONS: Based on the foregoing and the result of your audit, compute for the following: following: (Round off present value factors to four decimal places.) 1.How much is the total interest income from lease that will be earned by Real Inc.? a.

P2,869,988

c. P3,675,616

 b. P3,389,748

d.

0

2.Real, Inc. should report profit on the sale at a.

P1,330,252

c. P1,050,012

 b. P1,044,384

d. P1,338,492

3.How much should be reported by Quezon Co. as liability under finance lease as of December 31, 2010? a.

P4,143,593

c. P4,273,410

 b.

P4,446,613

d. P

0

4.How much should be reported by Quezon Co. under current liabilities as liability under finance lease as of December 31, 2010? a.

P356,798

c.

 b. P378,207

P394,252

d. P

0

5.How much interest expense should be reported by Quezon Co. in relation to the lease for the year ended December 31,2010? a.

P508,064

c. P543,398

 b. P501,793

Answers: 1) B;

d.

2)A;

3)B;

4)A;

5)C

Suggested Solution: Question No.1 Gross investment in the lease : Minimum lease payments (P440,000 x 18)

P7,920,000

0

 

Unguaranteed residual value  Net Investment in the lease:

800,000

P8,720,000

PV of minimum lease payments (440,000 x 11.4773)

5,050,012

PV of unguaranteed residual value (800,000 x 0.3503)

280,240

Total unearned interest income

_5,330,252 P3,389,748

Question No.2 Sales (present value MLP)

P5,050,012

Less cost of sales (4,000,000 –  (4,000,000 – P280,240) P280,240)

__3,719,760

Profit on Sale

P1,330,252

Question No.3 Finance lease liability (440,000 x 11.4773)

P5,050,012

Less lease payment, 1/1/10

440,000

Balance,1/1/10

4,610,012

Less principal payment on 7/1/10: Total payment

P440,000

Applicable to interest (P4,610,012 x 12% x 6/12)

276,601

Balance, 12/31/10

__163,399 P4,446,613

The lease shall be accounted for as finance lease because the present value of the minimum lease  payments amount to substantially all of the fair value of the leased asset at the inception of the lease (P5,050,012/P5,330,250 = 95%). Question No.4 Principal payment due, 1/1/11: Total payment

P440,000

Applicable to interest (4,446,613x 12% x 6/12)

266,797

P173,203

Principal payment due, 7/1/11 Total payment

440,000

Applicable to interest [(P4,446,613 –  [(P4,446,613 – P173,203) P173,203) x 12% x 6/12]

256,405

183,595

Current portion of finance lease liability, 12/31/10

P356,798

Question No. 5 1/1/10 to 6/30/10 (P4,610,012 x 12% x 6/12)

P276,601

7/1/10 to 12/31/10 (P4,446,613 x 12% x 6/12)

266,797

Total interest expense

P543,398

PROBLEM NO. 19 – Sale  – Sale and lease back

Guihayangan Co. purchase land and constructs a service station and car wash for a total of P6,750,000.At January 2,2010, when construction is completed, the facility and land on which it was constructed are sold to a major oil company for P7,500,000 and immediately leased from the oil company by Guinayangan. Fair value of the land at time of the sale was P750,000. P75 0,000. The lease is a 10-year,noncancelable lease. The agreement requires equal rental payments at the end of each year beginning December 31,2010. The interest rate implicit in the lease is 10%. Guinayangan uses straight-line depreciation for its other various business holdings. The economic life of the facility is 15 years with zero salvage value. Title to the facility and land will pass to Guinayangan at termination of the lease. QUESTIONS: Based on the above and the result of your audit, answer the following: (Round off present value factors to four decimal places) 1.The amount of annual lease payment is a.

P1,098,526

c. P 976,467

 b. P1,220,584

d. P1,109,632

2.The total lease-related expenses to be recognized by the lessee during 2010 is a.

P1,000,000

c. P1,075,000

 b. P1,425,000

d. P1,200,000

3. The total lease-related income to be recognized by the lessee during 2010 is a.

P75,000

c. P750,000

 b. P50,000

d. P

0

4. The total lease-related income to be recognized by the lessor during 2010 is a.

P675,000

c. P750,000

 b. P600,000

d. P

0

5.The amount to be reported under current liabilities as liability under finance lease as of December 31,2010 is a.

P517,642

c. P414,114

 b. P470,595

d. P465,879

Answers: 1)B;

2)D;

3)A;

4)C;

5)A

Suggested Solution: Question No. 1 Cost of facility (purchase price)

P7,500,000

Divide by (PV of ordinary annuity of P1 at 10% for 10 periods) Annual lease payment

6.1446 P1,220,584

Question No. 2 Interest expense (P7,500,000 x 10%)

P 750,000

Depreciation Expense (P7,500,000-P750,000/15) Total

450,000 P1,200,000

Question No. 3 Selling price Less cost of facility Gain on sale and leaseback Divide by lease term

P7,500,000 6,750,000 750,000 10

Gain to be recognized in 2010

P

75,000

 If a sale and leaseback transaction results in a finance lease, any an y excess e xcess of sales proceeds over the carrying amount shall not be immediately recognized as income by a seller-lessee. Instead, it  shall be deferred and amortized over the lease term.(PAS 17 par. 59)

Question No. 4 Interest income in 2010 (P7,500,000 x 10%)

P750,000

Question No. 5 Finace lease liability, 1/2/10

P7,500,000

Less principal payment on 12/31/10: Total payment in 2010

P1,220,584

Less applicable to interest (P7,500,000 x 10%)

750,000

___470,584

Balance, 12/31/10

P7,029,416

Rental payment in 2011

P1,220,584

Less applicable to interest (P7,029,416 x 10%)

702,942

Current portion of finance lease liability

P 517,642

 Pension PROBLEM NO. 20 –  Pension The following information relates to the defined benefit pension plan of the Tiaong Company Compan y as of January 1,2009: Projected benefit obligation (PBO)

P16,150,000

Fair value of plan assets

15,135,000

Unrecognized prior service cost

1,050,000

Unrecognized actuarial gain or loss

0

Pension data for the years 2009 and 2010 follows: 2009

2010

Current service cost

P 870,000

P1,150,000

Contribution to the plan

1,200,000

1,250,000

Benefits paid to retirees

1,320,000

1,400,000

Actual return on plan assets

263,500

1,800,000

Amortization of past service cost

210,000

186,667

Actuarial change increasing PBO

800,000

-

Settlement interest rate

11%

11%

10%

10%

Long-term expected rate of return on Plan assets

As of January 1,2010,the remaining expected service life of employee was 5 years. QUESTIONS: Based on the above result of your audit, answer the following: 1.What is the 2009 net pension expense? a.

P2,593,000

c. P1,200,000

 b. P4,370,000

d. P1,343,000

2.The projected benefit obligation as of December 31,2009 is a.

P18,276,500

c. P17,476,500

 b. P16,973,000

d. P16,173,000

3.The prepaid/accrued pension expense on December 31,2009 is a.

P1,358,000

 b. P3,153,000

c. P108,000 d. P

0

4.What is the 2010 net pension expense? a.

P1,863,702

c. P1,547,082

 b. P1,250,000

d. P1,819,232

5.The prepaid/accrued pension expense on December 31,2010 is a.

P 0

 b. P3,143,302

c. P1,655,082 d. P 721,702

Answers:1)D;

2)A;

3)C;

4)A;

5)D

Suggested Solution: Question No. 1 Current Service Cost Interest cost (P16,150,000 x 11%) Expected return on plan assets (P15,135,000 x 10%) Amortization of past service cost  Net pension expense

P

870,000 1,776,500 (1,513,500) 210,000

P 1,343,000

The entity shall recognize the net total of o f the following amounts in profit or loss:       

current service cost; interest expense; expected return on plan assets; actuarial gains and losses, as required in accordance with the entity’s accounting policy;  past service cost, to the extent recognized effect of any plan curtailments or settlements; and the effect of the limit in paragraph 58(b) of PAS 19,unless recognized outside ou tside profit or loss.

Current service cost is the increase in the present value of the defined benefit obligation resulting from employee service in the current period.  Interest cost is the increase increase during a period period in the present value of a defined benefit obligation which arises because the benefits are one period closer to settlement. The return on plan assets is interest, dividends and other revenue derived from the plan assets, together with realized and unrealized gains or losses on the plan assets, less any cost of administering the plan and less any tax payable by the plan itself.  Plan assets comprise: (a) assets held by a long-term employee benefit fund; and (b) qualifying insurance policies.  Assets held by a long-term employee benefit fund are assets (other than than nontransferable financial instruments issued by the reporting entity) that: (a) are held by an entity (a fund) that is legally separate from the reporting entity and exists solely to pay or fund employee benefits; and (b) are available to be used only to pay or fund employee benefits, are not available to the reporting entity’s own creditors (even in bankruptcy), and cannot be returned to the reporting entity, unless either: (i)the remaining assets of the fund are sufficient to meet all the related employee benefit obligations of the plan or the reporting entity; or

(ii) the assets are returned to the reporting entity to reimburse it for employee benefits already paid.  A qualifying insurance policy is an insurance policy issued by an insurer that is not a related party (as defined in PAS 24 Related Related Party Disclosures) of the reporting entity, if the proceeds of the  policy: (a) can be used only to pay or fund employee benefits under a defined benefit plan; and (b) are not available to the reporting entity’s own creditors (even in bankruptcy) and cannot be paid to the th e reporting entity, unless either; (i)the proceeds represent surplus assets that are not needed for the policy to meet all the related employee benefit obligations; or (ii)the proceeds are returned to the reporting entity to reimburse it for employee benefit already paid.  Actuarial gains and losses comprise: (a) experience adjustments (the effects of differences between the previous actuarial assumptions and what has actually occurred); and (b) the effects of changes in actuarial assumptions  PAS 19 specifies that if the accumulated unrecognized actuarial gains and losses exceedn10% of the greater of the defined benefit obligation or the fair value of plan assets, a portion of that net  gain or loss is required to be recognized in accordance with the entity’s accounting policy. policy. The  portion recognized is the excess divided by the expected average a verage remaining working lives of the  participating employees. Actuarial gains and losses that do not breach the 10% limits described d escribed above (the ’corridor’) need not to be recognized –  although  although the enterprise may choose to do so.  Past service cost cost is the increase in the present present value of the defined benefit obligation for employee  service in prior periods, resulting in the current period from the introduction of, or changes to,  post-employment benefits ben efits or other long-term employee benefits. b enefits. Past Pa st service cost may be either  positive (where benefits are introduced or imposed) or negative (where existing benefits are reduced).  Past service service cost should be recognized immediately immediately to the extent that it relates to former employees or to active employees already vested (i.e. not conditional on future employment). Otherwise, it  should be amortized on a straight-line basis over the average period until the amended benefits become vested.  A curtailment occurs when an entity either: (a) is demonstrably committed to make a material reduction in the number of employees covered by a plan; or (b) amends the terms of a defined benefit plan such that a material element of future service by current employees will no longer qualify for benefits, or will qualify only for reduced benefits.  A settlement occurs o ccurs when an entity enters into a transaction that eliminates all further legal or constructive obligation for part or all of the benefits provided under a defined benefit plan, for example, when a lump-sum cash payment is mad e to, or on behalf of, plan participants in exchang e  for their rights to receive specified post-employment benefits.

 An entity shall recognize gains or losses losses on the curtailment or settlement settlement of a defined benefit plan when the curtailment or settlement occurs. The gain or loss on a curtailment or settlement shall comprise (a) any resulting change in the present value of the defined benefit obligation; (b) any resulting change in the fair value of the plan assets; (c) any related actuarial gains and losses and  past service cost that had not previously been recognized.

Question No. 2 Projected benefit obligation, 1/1/09 Current service cost Interest cost (P16,150,000 x 11%) Actuarial change increasing PBO Benefits paid to retirees Projected benefit obligation

P16,150,000 870,000 1,776,500 800,000 (1,320,000) P18,276,500

Question No. 3 Debits Fair value of plan assets, 12/31/09 Fair value of plan assets, 1/1/09 Contribution to the plan Actuarial return on plan assets Benefits paid to retirees

P15,135,000 1,200,000 263,500 (1,320,000)

P15,278,500

Unrecognized prior service cost, 12/31/09 (P1,050,000 –  (P1,050,000 – P210,000) P210,000)

840,000

Unrecognized actuarial loss, 12/31/09 Difference between expected and actual return on plan assets (P1,513,500 –  (P1,513,500 – P263,500) P263,500) Actuarial change increasing PBO

1,250,000 800,000

2,050,000 18,168,5000

Credit Projected benefit obligation, 12/31/09 (see no. 2)

18,276,500

Prepaid (Accrued) pension expense, 12/31/09

(P108,000)

 Alternative Computations: Debits Fair value of plan assets, 1/1/09

P15,135,000

Unrecognized prior service cost, 1/1/09

1,050,000 16,185,000

Credit Projected benefit obligation, 1/1/09

P16,150,000

Prepaid (Accrued) pension cost, 1/1/09

P

35,000

Prepaid (Accrued) pension cost, 1/1/09

P

35,000

Underfunding in 2009: Contributions to the plan  Net pension expense(see no.1)

P1,200,000 1,343,000

Prepaid (Accrued) pension expense, 12/31/09

(143,000) (P108,000)

Question No. 4 Current service cost

P1,150,000

Interest cost (P18,276,599 x 11%)

2,010,415

Expected return on plan assets (P15,278,500 x 10%)

(1,527,850)

Amortization of past service cost

186,667

Amortization of unrecognized net actuarial loss: Unrecognized net actuarial loss 1/1/10 Less corridor (P18,276,500 x 10%) Excess Divide by remaining service life Prepaid (Accrued) pension expense, 12/31/10

PROBLEM NO. 21 –  Pension  Pension

P2,050,000 1,827,650 222,350 5

(613,702) (P721,702)

You gathered the following information related to J omalig Company’s the defined benefit plan for the year ended December 31,2010:     

  

Current service cost of providing benefits for the year to Decembe r 31,2010: P54 million Average remaining working life of employees: 10 years Benefits paid to retired employees in the year: P5 5.8 million Contribution paid to fund: P37.8 million Present value of obligation to provide benefits: P3,960 million at January 1,2010, and P4,500 million at December 31,2010  Net cumulative unrecognized gains at January 1, 2010: P453.6 million Past service cost: P207 million. All of these benefits have vested. Discount rates and expected rates of return on plan assets: 1/1/10 1/1/11 Discount rate 5% 6% Expected rate of return on plan assets 7% 8%

QUESTIONS: Based on the above and the result of your audit, answer the following: 1.The amount to be recognized in the statement of the financial position as of January 1, 2010 is a.

P633.3 million

c. P957.6 million

 b.

P453.6 million

d. P455.4 million

2.The amount of actuarial gain to be recognized in profit or loss for the year ended December 31,2010 is a.

P7.20 million

c. P3.60 million

 b.

P5.76 million

d. P

0

3.The net pension expense to be recognized in profit or loss for the year ended December 31,2010 is a.

P188.64 million

c. P3.60 million

 b.

P183.60 million

d. P270.00million

4.The unrecognized actuarial gain as of December 31,2010 is a.

P448.2 million

c. P604.44 million

 b.

P453.6 million

d. P

0

5.The amount to be recognized in the statement of financial position as of December 31,2010 is a.

P784.44 million

c. P180.00 million

 b.

P682.20 million

d. P455.40 million

Answers: 1)A;

2)B;

3)A;

4)C;

5)A

Suggested Solution: Question No. 1 Debit Fair value of plan assets, 1/1/10 Credits Present value of obligation, 1/1/10  Net cumulative unrecognized gains, 1/1/10 Prepaid (Accrued) pension expense, 1/1/10

P3,870.0

P3,960.0 453.6 4,413.60 (P633.6)

Question No. 2  Net cumulative unrecognized gains, 1/1/10 Less corridor (3,960 million x 10%) Excess Divide by average remaining working life of employees Amount to be recognized in profit or loss

453.6 396.00 57.6 10 P 5.76

Question No. 3 Current service cost Interest cost (P3,960 million x 5%) Expected return on plan assets (P3,780 million x 7%) Past service cost Actuarial gain recognized (see no.2)  Net pension expense

P54.00 198.00 (264.60) 207 (5.76) P188.64

Question No. 4  Net cumulative unrecognized gains, 1/1/10 Actuarial loss on obligation (see computation) Actuarial gain on plan assets (see computation) Actuarial gain recognized (see no.2)  Net cumulative unrecognized gains, 12/31/10

453.60 (136.80 293.40 (5.76) P604.44

 Actuarial loss on obligation Present value of obligation, 1/1/10 Current service cost Interest cost (P3,960 million x 5%) Past service cost Benefits paid Actuarial loss on obligation (squeeze) Present value of obligation, 12/31/10  Actuarial gain on plan assets Fair value of plan assets, 1/1/10 Expected return on plan assets (P3,780 million x 7%) Contribution to the plan Benefits paid to retirees Actuarial gain on plan assets (squeeze) Fair value of plan assets, 12/31/10

P3,960.00 54.00 198.00 207.00 (55.80) 136.80 P4,500.00

P3,780.00 264.60 37.80 (55.80) 293.40 P4,320

Question No. 5 Debit Fair value of plan assets, 12/31/10 Credits Present value of obligation, 12/31/10  Net cumulative unrecognized gains, 12/31/10 Prepaid (Accrued) pension expense, 12/31/10

P4,320.00

P4,500.00 P604.44 5,104.44 (P784.44)

 Pension PROBLEM NO. 22 –  Pension The following information relates to the defined benefit pension plan of the Lopez Corporation for the year ended December 31,2010:

Projected benefit obligation, January 1 Projected benefit obligation, December 31 Fair value of plan assets, January 1 Fair value of plan assets, December 31

P13,800,000 13,150,000 11,500,000 13,600,000

Unrecognized past service cost, January 1 Unrecognized net actuarial loss, January 1 Contribution to the plan Benefits paid to retirees Amortization of past service cost Actuarial change decreasing PBO Present value of available refunds and reductions in future contribution to the plan Expected return on plan assets Settlement rate Expected average remaining working lives of the employees participating in the plan

500,000 1,300,000 2,000,000 1,800,000 100,000 906,000 250,000 14% 12% 10 years

QUESTIONS: Based on the above and the result of your audit, determine the following: 1.Current service cost for 2010 a.

P400,000

 b. P1,778,000

c. P506,000 d. P650,000

2.Actual return on plan assets in 2010 a.

P100,000

 b. P1,610,000

c. P1,900,000 d. P2,100,000

3.Unrecognized net actuarial loss as of December 31,2010 a.

P104,000

 b. P96,000

c. P1,904,000 d. P1,010,000

4.Amount to be recognized in the statement of financial position as of December 31,2010 a.

P650,000

c. P954,000

 b. P754,000

d. P504,000

5.Net amount to be recognized in 2010 profit or loss a.

P761,000

c. P996,000

 b. P546,000

d. P746,000

Answers: 1)A;

2)C;

3)A; 3)A;

4)B,

5)D

Suggested Solution: Question No. 1 Projected benefit obligation, January 1,2010 Current service cost (squeeze) Interest cost (P13,800,000 x 12 %) Actuarial change decreasing PBO Benefits paid to retirees Projected benefit obligation, December 31,2010

P13,800,000 400,000 1,656,000 (906,000) (1,800,000) P13,150,000

Question No. 2 Fair value of plan assets, January 1 ,2010 Actual return on plan assets (squeeze) Contribution to the plan Benefits paid to retirees Fair value of plan assets, December 31,2010

P11,500,000 1,900,000 2,000,000 (1,800,000) P13,600,000

Question No. 3 Unrecognized net actuarial loss, January 1,2010 Actuarial change decreasing PBO Difference between actual and expevted return on plan assets [P1,900,000 - (P11,500,000 x 14%)] Unrecognized net actuarial loss, December 31,2010

1,300,000 (906,000)

(290,000) P104,000

Question No. 4 Debits Fair value of plan assets,12/31/10 Unrecognized past service cost, 12/31/10 (P500,000 - P100,000) Unrecognized net actuarial loss, 12/31/10 Credit

P13,600,000

400,000 P104,000 P14,104,000

Present value of obligation, 12/31/10 Prepaid (Accrued) pension expense, 1/1/10

P13,150,000 P954,000

The amount recognized as a defined benefit liability shall be the net total of the following amounts: (PAS 19 par. 54) (a) The present value of the defined benefit obligation at the end of the reposting period; (b) Plus (b)  Plus any actuarial gains (less any actuarial losses) not recognized; (c)  Minus any past services cost not yet recognized; (d) Minus (d)  Minus the fair value at the end of the reporting period of plan assets (if any) out of which the obligations are to be settled directly.  If the calculation of the statement of the financial position amount as set out above results in an asset, the amount recognized should be limited to the net total of unrecognized actuarial losses and past service cost, plus the present value of a vailable refunds and reductions in future contributions to the plan (PAS 19 par.58). The asset ceiling is computed below: Unrecognized net actuarial loss Unrecognized past service cost  Present value of available refunds and reductions in future contributions to the plan  Limit on the amount that may be recognized as asset Since the amount computed based on PAS 19 par 58b is lower than the amount computed based on PAS 19 par. 54, the amount to be recognized in the statement of financial position should be limited to P754,000. The excess of P200,000 is recognized in accordance with the entity’s accounting policy (i.e. either within or outside ou tside profit or loss).

Question No. 5 Current service cost (see no. 1) Interest cost (P13,800,000 x 12 %)

P400,000 1,656,000

Expected return on plan assets P11,500,000 x 14%) Actuarial loss recognized (see below) Past service cost amortization Excess over limit on recognized asset (see no. 4)  Net pension expense

(1,610,000) 0 100,000 200,000 P746,000

Unrecognized net actuarial loss, 1/1/10 Less corridor (P13,800,000) Excess

P1,300,000 1,380,000 P 0

 Debt restructuring PROBLEM NO. 23 –  Debt On December 31,2010, Maca Company Compan y was indebted to Lelon Co. onyaears P2,000,000,10% no te. Only interest had been paid to date.Due to its financial difficulties Maca Company has negotiated a restructuring of its note payable. The parties agreed that Maca Company would settle the debt on the following terms: 





Settle one-half of the note by transferring land with a recorded value of P800,000 and fair value of P900,000. Settle one-fourth of the note by transferring 200,000 shares of P1 par ordinary shares with a fair market value of P15 per share. Modify the terms of the remaining one-fourth of the note by reducing the interest rate to 5%, extend the due date three years from the date of restructuring and reducing the principal to P300,000.

QUESTIONS: Based on the above and the result of your audit, determine the following: 1.Gain on extinguishment of debt on the P1million note a.

P300,000

c. P100,000

 b. P200,000

d. P

0

2.Share premium to be recognized on the settlement of P500,000 note by issuing ordinary shares a.

P2,500,000

c. P2,300,000

 b. P300,000

d. P

0

3.Total gain on extinguishment of debt a.

P437,306

c. P550,006

 b. P337,306

d. P

0

4.Interest expense in 2011 a.

P15,000

c. P7,500

 b. P26,269

d. P13,134

5.Carrying amount of the note payable as of December 31,2011 a.

P273,963

c. P142,494

 b. P262,694

d. P300,000

Answers:1)B;

2)B;

3)A;

4)B,

5)A

Suggested Solution: Question No. 1 Carrying amount of liability (P2,000,000 x 1/2) Less carrying amount of land Gain on extinguishment of debt

P1,000,000 800,000 P200,000

Question No. 2 Carrying amount of liability (P2,000,000 x 1/4) Less par value shares issued (200,000 x 1) Share premium

P500,000 200,000 P300,000

Question No. 3 Modification of terms: Carrying amount of liability (P2,000,000 x 1/4) Less present value of restructured debt: Principal (P300,000 x 0.7513) Interest (P300,000 x 5% x 2.4869) Gain on extinguishment of debt Asset swap (see no. 1) Total gain on extinguishemnt debt

P500,000 P225,390 __37,304

262,694 237,306 200,000 P437,306

 An entity shall remove a financial liability (or a part of a financial liability) from its statement of  financial position when, and only when, it is extinguished ie when the obligation specified in the contract is discharged or cancelled or expires. (PAS 39 par 39)  An exchange between an existing borrower and lender of debt instruments with substantially different terms shall be accounted for as an extinguishment of the original financial liability and the recognition of a new financial liability. Similarly, a substantial modification of the terms of an existing financial liability or a part of it (whether or not attributable to the financial difficulty of the debtor) shall be accounted for as an extinguishment of the original financial liability d the recognition of a new financial liability. (PAS 39 par.40) The terms are substantially different if the discounted present value of the ash flows under the new terms, including any fees paid net of any fees received and discounted using the original effective interest rate, is at least 10 percent different from the discounted present value of e remaining cash  flows of the original financial liability. liability. If an exchange of debt instruments or modification of terms is accounted for as an extinguishment, any cost or fees incurred are recogni zed as part of the gain or loss on the extinguishment. If the exchange or modification is not accounted for as an

extinguishment, any cost or fees incurred adjust the carrying amount of the liability and are amortized over the remaining term of the modified liability. (PAS 39 AC62) The difference between the carrying amount of a financial liability for part of a financial liability extinguished or transferred to another party and the consideration paid including any non cash assets transferred or liabilities assumed, shall be recognized in profit or loss. (PAS 39 par. 41)

Question No. 4 Interest expense in 2010 (P262,694 x 10%)

P26,269

Question No. 5 Carrying amount, 12/31/10 (see no.3) Less discount amortization for 2011: Effective interest (P262,694 x 9%)  Nominal interest (P300,000 x 5%) Carrying amount, 12/31/11

P262,694 P26,269 15,000

11,269 P273,963

 Income taxes PROBLEM NO. 24 –  Income The following difference enter into the reconciliation of accounting profit and taxable profit of Mulanay Company for the year ended December 31,2010, its first year of operations: Life insurance expense Excess tax depreciation Warranty expense Litigation accrual Unamortized computer software Unearned rent income deferred on the books but appropriately recognized in taxable profit Interest income from long-term certificate deposit

P100,000 2,000,000 200,000 500,000 3,000,000 400,000 200,000

Additional information: a. On July 1,2010 Mulanay paid insurance premium of P200,000 on o n the life of an officer with Mulanay Company as beneficiary.  b. Excess tax depreciation will reverse equally over a four- year period 2011-2014 c. The warranty liability is the estimated warranty cost that was recognized as expense in 2010 but deductible for tax purpose when actually paid. d. It is estimated that the litigation liability eill be paid in 2014

e. In January 2010, Mulanay Company incurred P4,000,000 of computer software cost. Considering the technical feasibility of the project, this cost was capitalized and amortized over 4 years for accounting purposes. However, the total amount was exp ensed in 2010 for tax purposes f. Rent income will be recognized during the last year of the lease, 2014. g. Interest income from the from long-term certificate of deposit is expected to be P200,000 each year until their maturity at the end of 2014. h. Accounting profit for 2010 is P10,000,0000. Tax rate is 35%

QUESTIONS: Based on the above and the result of your audit, determine the following: 1.Deferred tax liability a.

P1,050,000

c. P2,100,000

 b. P1,890,000

d. P1,750,000

2.Deferred tax asset a.

P385,000

c. P245,000

 b. P1,085,000

d. P210,000

3.Current tax expense a.

P2,100,000

c. P2,800,000

 b. P1,750,000

d. P1,820,000

4.Tax expense a.

P3,535,000

c. P3,465,000

 b. P3,500,000

d. P4,830,000

Answers:1)D;

2)A;

3)A;

4)C

Suggested Solution: Question No.1 Excess tax depreciation Unamortized computer software cost Taxable temporary differences

P2,000,000 3,000,000 P5,000,000

Deferred tax liability (P5,000,000 xx35%)

P1,750,000

 Deferred tax liabilities are amounts of income taxes payable in future periods in respect of taxable temporary differences Taxable temporary differences are temporary differences that will result in taxable amounts in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled. Temporary differences are differences between the carrying amount of an asset or liability in the  statement of financial position and its tax base.

Question No. 2 Warranty expense Litigation Accrual Unearned rent income Deductible temporary differences Deferred tax asset (P1,100,000 x 355)

P200,000 500,000 400,000 P1,100,000 P385,000

 Deferred tax assets are the amounts of income taxes recoverable in future periods in respect of: (a) Deductible (a)  Deductible temporary differences; (b) The carryforward of unused tax losses; and (c) The carryforward of unused tax credits  Deductible temporary differences are temporary differences that will result in amounts that are deductible in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled.

Question No. 3 Accounting profit  Nondeductible expense - life insurance expense  Nontaxable income - interest on LTCD Accounting profit subject to income tax Taxable temporary differences Deductible temporary differences Taxable profit Current tax expensef(P6,000,000 x 35%)

P10,000,000 100,000 (200,000) 9,900,000 (5,000,000) 1,100,000 P6,000,000 P2,100,000

Current tax is the amount of income taxes payable (recoverable) in respect of the taxable profit (tax loss) for a period. Taxable profit (tax loss) is the profit (loss) for a period, determined in accordance with the rules established by the taxation authorities, upon which income taxes are payable(recoverable).  Accounting profit is profit or loss for a period before deducting tax expense.

Question No. 4 Current tax expense Increase in deferred tax liability Increase in deferred tax asset Total income tax expense

P2,100,000 1,750,000 (385,000) P3,465,000

 Alternative computation: Accounting profit subject to income tax Multiply by income tax rate Total income tax expense

P9,900,000 _______35% P3,465,000

Tax expense (tax income) is the aggregate amount included in the determination of profit or loss  for the period in respect of current tax and deferred tax. It comprises current tax expense (current tax income) and deferred tax expense (deferred tax income).

PROBLEM NO. 25 –  Income  Income taxes

The accounting profit before tax for the year ended December 31,2010 for Doughty Corporation amounted to P175,900 and included: Interest income Long-service leave expense Doubtful dets expense Depreciation - plant (15% p.a) Rent expense Entertainment expense (non-deductible)

P11,000 7,000 4,200 33,000 22,800 3,900

The draft statement of financial position at December 31,2010 contained the following assets and liabilities:

Cash

2010 P9,000

2009 P7,500

Accounts receivable Allowance for doubtful debts Inventory Interest receivable Prepaid rent Plant Accumulated depreciation-`plant Deferred tax asset Accounts payable Provision for long-term service leave Deferred tax liability

83,000 (5,000) 67,100 1,000 2,800 220,000 (99,000) ? 71,200 64,000

76,800 (3,200) 58,300 0 2,400 220,000 (66,000) 30,600 73,600 61,000

?

720

 Additional information   

The tax depreciation rate for plant is 10% 1 0% p.a, straight line The tax rate is 30% The company has P15,000 in tax losses carried forward from previous year.

QUESTIONS: Based on the above and the result of your audit, compute for the following as of and for the year ended December 31,2010: 1.Current tax liability a.

P51,120

c. P58,260

 b. P53,590

d. P53,760

2.Deferred tax liability a.

P1,140

 b. P20,340

c. P19,200 d. P11,040

3.Deferred tax asset a.

P24,000

c. P30,600

 b. P12,540

d. P11,400

4.Deferred tax expense a.

P180

 b. P6,780

c. P36,300 d. P38,580

Answers:1)D;

2)A;

3)C;

4)A

Suggested Solution: Question No. 1 Accounting profit Add (deduct) adjustments: Income and expenses - accounting Interest income Long-service leave expense Doubtful dets expense Depreciation - plant (15% p.a) Rent expense Entertainment expense (non-deductible)

P175,900

(11,000) 7,000 4,200 33,000 22,800 3,900 235,800

Income and expenses - taxation Interest collected (P11,000-P1,000) Long-service leave paid (P61,000+P7,000-P64,000) Bad debts written off (P3,200+P4,200-P5,000) Depreciation-plant (P2,800+P22,800-P2,400) Rent paid (P2,800+P22,800-P2,400) Tax losses from prior years Taxable profit Multiply  by rate Current tax expense/liability

10,000 (4,000) (2,400) (22,000) (23,200) (15,000) 179,200 _____ 30% P53,760

The following comparison of the carrying amount a mount of assets and liabilities and their tax base at  December 31,2010 will be helpful in computing requirements 2 to 4: Carrying amount

Tax base

Difference

Remarks**

P78,000

P83,000

P5,000

Deductible

1,000 2,800 121,000

154,000*

Accounts receivable Interest receivable Prepaid rent Plant Provision for leave *[P220,000 –  *[P220,000 –  (220,000  (220,000 x .1 x.3)]

64,000

0

1,000 2,800 33,000

Taxable Taxable Deductible

64,000

Deductible

**If the carrying amount of asset is higher h igher than tax base - Taxable Taxa ble  If the carrying amount of asset is lower than tax base –  base –  Deductible  Deductible  If the carrying amount of liability is higher than tax base - Deductible  If the carrying amount of liability is lower than tax base - Taxable

Question No. 2 Taxable temporary differences x tax rate Deferred tax liability, 12/31/10

3,800 30% P1,140

Question No. 3 Taxable temporary differences x tax rate Deferred tax liability, 12/31/10

P102,000 30% P30,600

Question No. 4 Change in deferred tax liability (P1,140 - P720) Change in deferred tax asswt (P30,600-P30,360) Deferred tax expense (benefit)

P420 (240) P180

PROBLEM NO. 26  –  Substantive audit procedures for liabilities

Select the best answers for each of the following: 1. The auditor will most likely perform extensive t est for possible understatement of a. Revenue

c. Liabilities

 b. Assets

d. Equity

2. In auditing accounts payable, an auditor's procedures most likely will focus primarily on management's assertion of a. Existence  b. Completeness c. Presentation and Disclosure d. Valuation and allocation

3.Which of the following audit procedures is not appropriate for addressing the assertion of valuation? a. Confirm with creditors  b. Test for unrecorded liabilities. c. Perform analytical procedures. d. Verify accounts payable trial balance.

4.Which of the following is a substantive test that an auditor most likely would perform to verify the existence and valuation of recorded accounts payable? a. Vouching selected entries in the accounts payable subsidiary ledger to purchase orders and receiving reports.  b. Confirming accounts payable balances with known suppliers who have zero balances. c. Investigating the open purchase order file to ascertain that pre-numbered purchase orders are used and accounted for. d. Receiving the client's mail, unopened, for a reasonable period of time after the year-end to search for unrecorded vendor's invoices.

5.Auditor confirmation of accounts payable balances at the end of the reporting period may be unnecessary because a. There is likely to be other reliable external evidence to support the balances.  b. The duplication of cut-off tests. c. Accounts payable balances at the end en d of the reporting period may not be paid before the audit is completed. d.Correspondence with the audit client's attorney will reveal all legal activity by vendors for nonpayment. 6. To determine whether accounts payable are complete, an auditor performs a test to verify that all merchandise received is recorded. The population p opulation of documents for this test consists of all a. Payments vouchers

c. Purchase requisitions

 b. Receiving reports

d. Vendor’s invoices

7. An auditor traced a sample of purchase orders and the related receiving reports to the pu rchases  journal and the cash disbursement journal. The purpose of the substantive audit aud it procedure most likely was to

a. Verify that cash disbursements were for goods actually received.  b. Determine that purchases were properly recorded. c. Test whether payments were for goods actually ordered. d. Identify unusually large purchases that should be investigated earlier.

8. Which of the following procedures would an auditor most likely perform in searching for unrecorded payables? a. Compare cash payments occurring after the end of the reporting period with the accounts payable trial balance  b. Reconcile receiving reports with related cash payments made just prior to year-end c. Contrast the ratio of accounts payable pa yable to purchases with the prior year’s ratio d. Vouch a sample of creditor balances to supporting invoices, receiving reports, and purchase orders

9. When an auditor selects a sample of items from the vouchers payable register for the last month of the period under audit and traces these items to underlying documents, the auditor is gathering evidence primarily in support of the assertion that a. Recorded obligations were paid  b. Incurred obligations were recorded in the correct period c. Recorded obligations were valid d. Cash disbursements were recorded as incurred obligations

10. In conducting a search for unrecorded liabilities, the auditor should do all but th e following: a. Examine prior year’s audit workpapers to ascertain that adjustments for unrecorded liabilities have not been overlooked.  b. Examine invoices paid a few days prior to the end of the reporting period. c. Examine paid invoices for a short period following the end of the reporting period and trace to client’s year -end -end adjustments for unrecorded liabilities.

11. An audit procedure applicable ap plicable to testing the year-end cutoff of liabilities is a. Reviewing the general journal for unusual entries recorded immediately after year-end  b. Examining vendor invoices received subsequent to year-end for shipment date and terms of shipment

c. Tracing recorded liabilities to supporting documents d. Preparing an aging schedule for accounts payable

12. Two months before the year end, the bookkeeper erroneously recorded the receipt of a long term bank loan by a debit to cash and credit to sales. Which of the following is the most effective  procedure for detecting this type of error? a. Analyze the notes payable journal  b. Analyze bank confirmation information c. Prepare a year-end bank reconciliation d. Prepare a year end bank transfer schedule

13. An auditor usually examines receiving reports to support entries in the a. Sales journal and sales return journal  b. Check register and sales journal c. Voucher register and sales journal d. Vouchers register and sales return journal

14. Which of the following is not used to test overstatements and understatements of accounts  payable? a. Unmatched receiving reports  b. Canceled vouchers packages c Cash receipts records d. Cash disbursement records 15. During the course of an audit, an auditor observes that the recorded interest expense seems excessive in relation to the balance in long term debt. This observation can lead the auditor to suspect that a. Long-term debt is overstated  b. Long-term debt is understated c. Premium on bonds payable is understated d. Discounts on bonds payable is overstated

16. An auditor’s program to examine long-term long-term debt most likely would include steps that require a. Correlating interest expense recorded for the pe riod with outstanding debt  b. Inspecting the accounts payable subsidiary ledger for unrecorded long term debt c. Comparing the carrying amount of the debt to its year end market value d. Verifying the existence of the holders of o f the debt by direct confirmation

17. A CPA analyzes the accrued interest payable accounts for the year, recomputes the amounts of payments and beginning and ending balances and reconciles to the interest expense account. Which error or questionable practice below has the best chance of being detected by this specific audit procedure? a. Interest paid on an open account was charge to the purchase accounts  b. Interest revenue of P120 on a note receivable was credited against miscellaneous expense c. A note payable had not been recorded. Interest of P300 on the note was properly paid and charge to the interest expense accounts d. There was a violation of a term in the client’s loan agreement prohibiting d ividends on common stocks unless net income available for interest and dividends is at least three times interest, requirements.

18. During the audit of a publicly held company, the auditor could obtain written confirmation regarding long term bond transactions from the a. Bond holders

c. Client’s Attorney

 b. Internal Auditors

d. Trustee

19. During its fiscal year, a compan y issued, at a discounts, a substantial amount of first mortgage  bonds. When performing audit work, the independent auditors a. Confirms the existence of the bondholders  b. Receiving the minutes for authorization c. Traces the net cash received from the issuance to the bonds payable accounts d. Inspects the records maintained by the bond trustee

20. An auditor’s purpose in reviewing the renewal of note payable shortly after the end of the reporting period most likely is to obtain evidence concerning management’s assertions about a. Existence

c. Presentation and Disclosure

 b. Completeness

d. Valuation and Allocation

Answers: 1. c

6. b

11. b

16. a

2. b

7. b

12. b

17. c

3. c

8. a

13. d

18. d

4. a

9. c

14. c

19. b

5. a

10. b

15. b

20. c