Warranty Obligation And Expects

If an entity has a warranty obligation and expects, with more than 50% probability, it will result in some payments from the entity, a provision should be made for: 

50% of the expected amount of the payments



The expected amount of the payments



An amount agreed upon by management



The entire amount of the sales in the period

Correct A provision should be made for the expected amount of the transfer of economic benefits.

Which of the following is not a restructuring cost? 

Fundamental change in operations



Retraining staff



Sale of a line of business



Change in management structure

Correct Retraining or relocating existing staff is not a restructuring expense as it is associated with the ongoing activities of an entity.

Which of the following does not create a constructive obligation under IAS 37? 

Established pattern of past practice



Legislation



Published policies



A current statement

Correct Legislation creates a legal obligation under IAS 37. A constructive obligation is an obligation derives from an entity’s actions whereby a valid expectation is created that it will discharge responsibilities. These may be created by:   

An established pattern of past practice Published policies A sufficiently current statement

Which of the following is a restructuring cost under IAS 37? 

Relocation of staff



Marketing



Investment in new distribution networks



Relocation of business activities from one region to another

Correct Under IAS 37, the following are examples of events that may fall under the definition of restructuring:    

sale or termination of a line of business the closure of business locations in a country or region or the relocation of business activities from one country or region to another changes in management structure, for example, eliminating a layer of management; and fundamental reorganisations that have a material effect on the nature and focus of the entity’s operations. Provisions are reported as part of trade and other payables in the financial statements. 

True



False

Correct False – Provisions are reported separately in the financial statements. By contrast, accruals are often reported as part of trade and other payables. Podge Limited created a provision for $100,000 against a certain event which never materialised. During the financial year, another event costing $80,000 occurred. May Podge Limited use part of the $100,00 provision against the new event? 

Yes



No

Correct No – A provision should only be used for the expenditure which is it was originally recognised. To allow a provision to be used for another event would conceal the impact of the different events. When a restructuring involves the sale of an operation, at what point may an obligation arise under IAS 37? 

When business is marketed for sale



When a preferred buyer is located



When an expression of interest is filed



When a binding sale agreement is executed

Correct Under IAS 37, no obligation arises for the sale of an operation until the entity is committed to the sale, ie there is a binding sale agreement. A provision is the same as an accrual. 

True



False

Correct False – Provisions can be distinguished from accruals because there is uncertainty about the timing or amount of the future expenditure required in settlement. Accruals are liabilities to pay for goods or services that have been received or supplied but have not been paid, invoiced or formally agreed with the supplier. Which of the following is not a disclosure requirement for a contingent liability?



Exact timing of outflow



Indication of uncertainties relating to the amount



Estimated financial effect



Possibility of any reimbursement

Incorrect The exact timing of the settlement of a contingent liability will be unknown. The disclosures for a contingent liability include, a brief description of the nature of the contingent liability and, where practicable: (a) an estimate of its financial effect, (b) an indication of the uncertainties relating to the amount or timing of any outflow, and (c) the possibility of any reimbursement When another party will reimburse some or all of the expenditure required to settle a provision, the reimbursement should be recognised… 

as a deduction against the provision



as a separate line in equity



as a separate asset



as a note to the financial statements

Incorrect Any amount received as a reimbursement should be noted in the financial statements as a separate asset. A contingent asset is one where ______ obligation will arise from past events, which will be confirmed by events in the future. 

a possible



a probable



an uncertain



a definite

Incorrect Possible – A contingent asset is a possible asset that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity. Contingent assets should be recognised in the financial statements when they are… 

Possible



Probable



Definite



Received

Incorrect Contingent assets are not recognised in the financial statements until they are received (ie. Actual assets). However, a contingent asset is disclosed where an inflow of economic benefits is probable. When another party will reimburse some or all of the expenditure required to settle a provision, the reimbursement should only be recognised when its receipt is…



Probable



Virtually certain



Possible



More probable than not

Incorrect The reimbursement shall be recognised when, and only when, it is virtually certain that reimbursement will be received if the entity settles the obligation. When another party will reimburse some or all of the expenditure required to settle a provision, the reimbursement should only be recognised when its receipt is… 

Probable



Virtually certain



Possible



More probable than not

Incorrect The reimbursement shall be recognised when, and only when, it is virtually certain that reimbursement will be received if the entity settles the obligation. The amount of a provision shall be the _________ of the expenditures expected to be required to settle the obligation. 

Market value



Fair value



Cost value



Present value

Correct Present value – An appropriate discount rate should be used which reflects the time value of money and the risks specific to the liability. Gains from the expected disposal of assets may be taken into account when measuring a provision. 

True



False

Incorrect False – Gains from the expected disposal of assets may not be taken into account when measuring a provision. An entity may avoid disclosure requirements if they expect it would seriously prejudice the position of the entity in dispute with other parties. 

True



False

Correct True – The entity must still disclose the general nature of the provision/contingency and an explanation of why is has not been disclosed. Where is a contingent liability contained in the financial statements? 

As a non-current liability



A current liability



In equity



A note to the financial statements

Correct Under IAS 37, an entity should not recognise a contingent liability. Instead it should be disclosed in the notes, unless the possibility of the liability materialising is remote. The cost of major overhauls of assets such as ships may be provisioned over a number of years prior to the overhaul. 

True



False

Correct False – A maintenance requirement or overhaul does not create an obligation, it is merely an intention. The entity may decide to dispose of the asset or abandon it to avoid incurring overhaul costs. A major overhaul may be considered a capital rather than revenue expenditure. The cost of major overhauls of assets such as ships may be provisioned over a number of years prior to the overhaul. 

True



False

Correct False – A maintenance requirement or overhaul does not create an obligation, it is merely an intention. The entity may decide to dispose of the asset or abandon it to avoid incurring overhaul costs. A major overhaul may be considered a capital rather than revenue expenditure. The cost of major overhauls of assets such as ships may be provisioned over a number of years prior to the overhaul. 

True



False

Correct False – A maintenance requirement or overhaul does not create an obligation, it is merely an intention. The entity may decide to dispose of the asset or abandon it to avoid incurring overhaul costs.

CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES However the liability is classified as noncurrent if the ledger has agreed on or before the end of the reporting period to provide a grace period ending at least twelve months after that date. In this context, a grace period within which the entity can rectify the breach and during which the lender cannot demand immediate repayment. PRESENTATION OF CURR ENT LIABILITIES PAS 1 stat es that as a minimum, the face of the statement of financial position shall include the following line items for current liabilities: a. Trade and other payables b. Current provisions c. Short term borrowing d. Current portion of long term debt e. Current tax liability The term “trade and other payables” is a line term for accounts payable, notes payable, accrued interest on notes payable, dividends payable and accrued expenses. ESTIMATED LIABILITIE S Are obligations which exist at the end of reporting period although their amount is not definite. Estimated liabilities also are either current or noncurrent in nature. Examples include estimated liability for premium, award points, warranties, gift certificate and bonus. CONTINGENT ASSET A contingent asset is a possib le asset that arises from past events and whose existence will be confirmed only by the occurrence or non occurrence of one or more uncertain future events not wholly within the control of the enterprise. An example is a claim that an enterprise is pursuin g through legal processes, where the outcome is uncertain. Contingent assets are not recognized in the financial statements since this may in the result in the recognition of income that may never be realized. T hey are continuously assessed to ensure that developments are appropriately reflected in the financial

statements. W here the inflow of economic benefits is probable, the contingent asset is disclosed. H owever, when the realization of income is virtually certain, the related asset is not a contingenc y anymore and its recognition is appropriate. CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES DISCLOSURE REQUIREME NTS 1. F or each class of provision, an entity should disclose:  C arrying amount at the beginning and end of the period;  A dditional provisions made in the period, including increases to exis ting provisions;  A mounts used during the period;  U nused amounts reversed during the period;  T he increase during the period in the discounted amount arising from the passage of time and the effect of any change in the discount rate;  A brief description of t he nature of the obligation and the expected timing of any resulting outflows of economic benefit;  A n indication of the uncertainties about the amount or timing of the outflows;  T he amount of any expected reimbursement, stating the amount of any asset that has been recognized for that expected reimbursement. 2. F or each class of contingent liability at the end of the reporting period, an entity should disclose a brief description of the nature of the contingent liability. 3.

W here an inflow of economic benefit s is probable , an enterprise should disclose a brief description of the nature of the contingent assets at the end of the reporting period and, where practicable, an estimate of their financial effect . CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES QUESTIONS THEORY 1. Which o f the following is not a characteristic of a liability? a. The obligation must be settled to an identified party b. It is a present obligation that entails settlement by probable future transfer or use of cash, goods or services. c. The liability must be an unavoi dable obligation. d. The transaction or event creating the obligation must have already o ccurred . 2. Which of the following is a current liability a. Dividends in arrears on preference share b. A dividend payable in the form of additional ordinary shares c. A cash divi dend payable to preference shareholders d. All of these 3. It is a marketing scheme whereby an entity grants award credits to customers and the entity can redeem the award credits in exchange for free or discounted goods or services. a. Customer loyalty program c . Marketing program b. Premium plan d. Loyalty program 4. A provision is an obligation that is uncertain as to

Amount Existence a. Yes Yes b. Yes No c. No Yes d. No No 5. An outflow of resources embodying economic benefits is regarded as “probable” when a. The probability that the event will occur is greater than the probability that the event will not occur. b. The probability that the event will not occur is greater than the probabilit y that the event will occur c. The probability that the event will occur is the same as the probability that the event will not occur. d. The probability that the event will occur is 50% likely. 6. Which of the following uncertainties is normally accrued? a. Pend ing or threatened litigation b. General or unspecified business risk CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES c. Obligations related to product warranties d. Risk of property loss due to fire 7. Estimated liabilities are disclosed in financial statements by a. Note to the financial statements b. Showing the amou nt among the liabilities but not extending to the liability total c. An appropriate of retained earnings d. Appropriate classifying them as regular liabilities in the statement of financial position 8. A retail store received cash and issued gift certificates that are redeemable in

merchandise. The gift certificates lapse one year after they are issued. How would the deferred revenue account be affected by the redemption and lapse of certificated, respectively? a. Decrease and No effect b. Decrease and Decrease c. No effe ct and No effect d. No effect and Decrease 9. Magazine subscriptions collected in advance are treated as a. A contra account to magazine subscription receivable b. Deferred revenue in the liability section c. Deferred revenue in the shareholder’s equity section d. Magazi ne subscription refund in the income statement in the period collected 10. A provision shall be recognized when I. An entity has a present obligation as a result of a pas event. II. It is probable that an inflow of resources embodying economic benefits will be required to settle the obligation. III. The amount of the obligation can be measured reliably. a. I and II only b. I and III only c. II and III only d. I, II and III ANSWERS – THEORY 1. A 6. C 2. D 7. A 3. A 8. B 4. A 9. C 5. B

10. B CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES QUESTION PROBLEM 1. The effe ctive interest on a 12 month zero interest bearing note payable of P300,000, discounted at bank at 10% is a. 11.11% b. 10.87% c. 10.00% d. 9.09% 2. JEL Company has long owned a manufacturing site that has now been discovered to be contaminated with toxic waste. T he en tity has acknowledged its responsibility for the contamination. A n initial clean up feasibility study has shown that it will cost at least P500,000 to clean up the toxic waste. D uring the current year, JEL Company has been sued for patent infringement and lost the case. A preliminary judgment of P300,000 was issued and is under appeal. The entity ’ s attorneys agree that it is probable that the entity will lose this appeal. W hat amount of provision should be accrued as liability? a. 500,000

b. 800,000 c. 300,000 d. 0 3. JPP Company sells contract agreeing to service equipment for a 3 year period. Information for the year ended December 31,2012 is as follows: Cash receipts from service contract sold P960 , 000 Service contract revenue recognized 780,000 Unearned service contract revenue, 1/1/12 540,000 In its December 31 , 2012 statement of financial position, what amount should JPP report as unearned service contract revenue? a. 240,000 b. 390,000 c. 550,000 d. 720,000 4. At December 31, 2012, CCL Company had 1,000 gift certificate outstanding, which had been sold to costumers during 2012 for P750. CCL operates on a gross margin of 60%. How much revenue pertaining to the 1,000 outstanding gift certificates should be deferred at December 31 , 2012 ? a. 750,000 c. 300,000 b. 450,000 d. 0 CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES 5. TOSHIBA Company sells equipment service contracts that cover a 2 year period. T he sale of each contract is P600. TOSHIBA ’

s past experience is that, of the total pesos spent for repairs on service contracts, 40% is inc urred evenly during the first contract year and 60% evenly during the second contract year. TOSHIBA sold 1,000 contracts evenly throughout 2011. I n its December 31, 2011 statement of financial position, what amount should Nokia report as deferred service r evenue? a. 540,000 b. 480,000 c. 360,000 d. 300,000 6. ABC Company’s promotional program indicated that for every 10 box tops returned to ABC, customers receive a perfume. Manny estimates that only 60% of the box tops reaching the market will be redeemed. Additional in formation is as follows: UNITS AMOUNT Sales of product 100,000 30,000,000 Perfumes purchased 5,500 4,125,000 Perfume s distributed 4,500 What is the amount of year end estimated liability associated with this promoti on? a. 4,125,000 b. 3,000,000 c. 4,500,000 d. 1,500,000 7. During 2011, NEWTECH Company introduced a new product carrying a 2 year warranty against defects. The estimated warranty costs related to peso sales are 3% within 12 months following sale and 4% in the second 1

2 months following sale. Sales are P7,500,000 for 2011 and P9,000,000 for 2012. Actual warranty expenditures are P185,000 for 2011 and P400,000 for 2012. On December 31, 2012, what is the estimated warranty liability? a. 100,000 b. 450,000 c. 570,000 d. 0 8. COMTE CH Inc., sells computers that carry a 3 year warranty against manufacturer’s defects. Based on company experience, warranty costs were estimated at P300 per computer. During 2012, COMTECH sold 24,000 computers and paid warranty costs of P1,700,000. In its profit or loss for the year ended December 31,2012, COMTECH should report warranty expense of a. 1,700,000 c. 5,500,000 b. 2,400,000 d. 7,200,000 CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES 9. Assuming that the company’s operation started in 2012, what is the liability for the warranty reported by COMTECH at December 31, 2012? Use the information given in no. 8 a. 1,700,000 b. 2,400,000 c. 5,500,000 d. 7,200,000 10. MTE Company has an incentive compensation plan under which a branch manager received 10% of the branch income after deduction of the bonus but be fore deduction of income tax. Branch income for the current before the bonus and income tax was P1,650,000. The tax rate is 30%. What is the bonus for the current year? a. 126,000 b. 150,000 c. 165,000 d. 180,000 ANSWERS –

PROBLEMS 1. Proceeds = 100% 10% Ef fective interest = 10% / 90% = 90% = 11.11% 2. E nvironmental cost P 500,000 Litigation cost 300,000 Total accrued liability P 800 ,000 3. Cash receipts from service contract sold P960, 000 Less: Service contract revenue recognized (780,000) Add: Unearned service contract revenue, 1/1/12 540,000 Unearned service contract revenue P7 20,000 4. Gift certificate Outstanding 1,000 Multiply by Amount of GCO x 750 Revenue P750,000 5. First co ntract year (40% x 600,000) 240,000 Second co ntract year (60% x 600,000) 360,000 Tot al contracts sold in 2011 600,000 CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES Since the contracts are sold evenly, only ½ of the 40% is earned in 2011 and ½ will be ea

rned in 2012. ½ of the 60% will be earned in 2012 and ½ will be earned in 2013. Thus, the deferred service contract revenue on December 31, 2011 is computed as follows: Total contracts sold ( 1,000 x 600) 600,000 Less: Contracts ea rned in 2011 (240,0 00 x ½) ( 120,000 ) Deferred service revenue December 31, 2011 P 480,000 Service contract revenue earned in 2012: Remaining ½ of the first contract year (240,000 x ½) 120,000 First ½ of t he second contract year (360,000 x ½) 180,000 Total service contract revenue earned in 2012 300,000 6. Perfumes to be distr ibuted (100,000 x 60% / 10) 6,000 Perfumes distributed 4,000 Balance 2,000 Multiply by cost of Perfumes x 750 Estimated liability P1,500,000 7. Warranty expense: 2011 (7,500,000 x 7%) 525,000 2012 (9,000,000 x 7%) 630,000 1,155,000 Actual warranty expenditures: 2011 185,000 2012

400,000 585,000 Warranty liability – December 31, 2012 P570 , 000 8. Computers Sold 24,000 Multiply by Estimated Warranty Cost x 300 Warranty Expense P7, 200,000 CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES 9. Warranty Expense P7,200,000 Less: Warranty Costs 1,700,000 P5,500,000 10. Income after bonus before tax (1,650,000/110%) 1,500,000 Bonus (10% x 1,500,000) P150,000 CHAPTER 1: CURRENT LIABILITIES, PROVISIONS, AND CONTINGENCIES REFERENCES:  I ntermediate Accounting; Volume 2; 2012 edition; By: Nenita S. Robles and Patricia M. Empleo  Financial Accounting; Volume 2; 2012 edition; By: Conrado T. Valix, Jose F. Peralta and Christian Aris M. Valix  Practical Accounting; Volume 1; 2011 edition; By: Conrado T. Valix and Christian Aris M. Valix  Theory of Accounts; Volume 2; 2012 edition; By: Conrado T. Valix and Christian Aris M. Valix

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