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PREMIUMS:
a) Net cost or expense per premium = Cost per premium + Distribution cost (-) Customer remittance
b) Total premium expense = Units sold x estimate of redemption x Net cost (a)
c) Premium liability = Premium expense less Net cost of premiums distributed
WARRANTY:
a) Warranty Expense (accrual method) = Sales x total percentage of expected repairs
b) Warranty Liability = Warranty expense less actual expenditures of cost of services performed
Problems
1. To increase sales, Lamar Company inaugurated a promotional campaign on June 30, 2017. Lamar placed a
coupon redeemable for a premium in each package of cereal sold at P300. Each premium cost P200. A premi-
um is offered to customers who send in 5 coupons and a remittance of P50. The distribution cost per premium
is P10. Lamar estimated that only 80% of the coupons issued will be redeemed. For the six months ended De-
cember 31, 2017, the following is available:
Packages of cereal sold 50,000
Premiums purchased 8,000
Coupons redeemed 30,000
1. What is the 2017 premium expense?
a. 1,280,000
b. 1,600,000
c. 1,200,000
d. 1,500,000
2. What is the estimated liability for premiums on December 31, 2017?
a. 320,000
b. 1,500,000
c. 400,000
d. 1,280,000
2. Jim Company includes one coupon in each box of laundry soap it sells. A towel is offered as a premium to cus-
tomers who send in 10 coupons and a remittance of P5. Data for the premium offer are:
2016 2017
Boxes of soap sold 1,000,000 1,500,000
Number of towels purchased at P50 per towel 40,000 65,000
Number of towels distributed as premium 35,000 58,000
Number of towels to be distributed as premium next period 3,000 5,000
1. What is the 2016 premium expense?
a. 1,575,000 c. 1,800,000
b. 1,710,000 d. 1,900,000
PAGE 2
2. What is the December 31, 2016 premium liability?
a. 150,000
b. 225,000
c. 450,000
d. 135,000
3. What is the 2017 premium expense?
a. 2,835,000
b. 2,700,000
c. 2,925,000
d. 2,250,000
4. What is the December 31, 2017 premium liability?
a. 225,000
b. 360,000
c. 315,000
d. 250,000
3. During 2017, Luciana Company introduced a new product carrying a two-year warranty against defects. The
estimated warranty costs related to peso sales are 3% within 12 months following sale and 5% in the second
12 months following sale. Sales and actual warranty expenditures for the years ended December 31, 2016 and
2017 are as follows:
Sales Actual expenditures
2016 40,000,000 1,000,000
2017 50,000,000 5,000,000
1. What is the 2016 warranty expense?
a. 1,200,000
b. 3,200,000
c. 2,000,000
d. 1,000,000
2. What is the December 31, 2016 warranty liability?
a. 1,000,000
b. 2,000,000
c. 1,200,000
d. 2,200,000
3. What is the 2017 warranty expense?
a. 4,000,000
b. 1,500,000
c. 5,000,000
d. 2,500,000
4. What is the December 31, 2017 warranty liability?
a. 3,000,000
b. 1,500,000
c. 1,900,000
d. 1,200,000
4. Jordan Company, a grocery retailer, operates a customer loyalty program. The entity grants program members
loyalty points when they spend a specified amount on groceries. Program members can redeem the points for
further groceries. The points have no expiry date. During 2016, the entity granted 10,000 points with a “stand
alone price” fair value of P100. Management expects that 8,000 of these points will be redeemed. The 2016
sales amounted to P7,000,000 during the year based on its stand-alone selling price. On December 31, 2016,
4,000 points have been redeemed in exchange for groceries. In 2017, the management revised its expectations
and now expects 9,000 points to be redeemed altogether. During 2017, the entity redeemed 4,100 points.
1. What is the total revenue recognized year ended December 31, 2016?
a. 7,000,000
b. 6,125,000
c. 6,562,500
d. 6,200,000
PAGE 3
2. What is the revenue earned from loyalty points for the year ended December 31, 2017?
a. 787,500 c. 350,000
b. 400,000 d. 410,000
ANSWERS: A,A,B,D,B,A,A,D,A,D,C,C
ANSWERS: B, C, A, A, D, D, C
1. On March 1, 2017, Jericho Company issued 5,000 of its P1,000 face value bonds at 110 plus accrued interest.
Jericho Company paid bond issue cost of P100,000. The bonds were dated November 1, 2016, mature on No-
vember 1, 2027, and bear interest at 12% payable semiannually on November 1 and May 1. What is the net
amount received by Jericho from the bond issuance?
a. 5,500,000
b. 5,700,000
c. 5,600,000
d. 6,000,000
2. On January 1, 2017, Gears Company issued 10,000 of its 12%, P1,000 face value bonds for P10,600,000, in-
cluding accrued interest. The bonds are dated October 1, 2016, mature on October 1, 2023 and pay interest
annually on October 1. The bonds were issued through an underwriter to whom Gears paid bond issue cost of
P150,000. On January 1 2017, what should Gears report as bonds payable?
a. 10,000,000
b. 10,450,000
c. 10,150,000
d. 10,300,000
3 On January 1, 2017, Cool Company issued eight-year bonds with a face value of P500,000 and a stated inter-
est rate of 6%, payable semiannually on June 30 and December 31. The bonds were sold to yield 8%. Table
values are:
Present value of 1 for 8 periods at 6% ................................................... .627
Present value of 1 for 8 periods at 8% ................................................... .540
Present value of 1 for 16 periods at 3% ................................................. .623
Present value of 1 for 16 periods at 4% ................................................. .534
Present value of annuity for 8 periods at 6% ......................................... 6.210
Present value of annuity for 8 periods at 8% ......................................... 5.747
Present value of annuity for 16 periods at 3% ....................................... 12.561
Present value of annuity for 16 periods at 4% ....................................... 11.652
1 The present value of the principal is
a. 267,000 c. 311,500
b. 270,000 d. 313,500
2. The present value of the interest is
a. 172,410 c. 186,300
b. 174,780 d. 188,415
3. The issue price of the bonds is
a. 441,780 c. 444,780
b. 442,410 d. 499,800
4. On January 1, 2017, Lucian Company issued 9% bonds in the amount of P5,000,000 which mature on January
1, 2027. The bonds were issued for P4,800,000 but Lucian had to pay for a P107,000 bond issuance cost. The
effective rate determined by Lucian is 10%. Interest is payable annually on December 31. Lucian uses the in-
terest method of amortizing bond discount. In its December 31, 2017 statement of financial position, what
amount should Lucian report as bonds payable?
a. 5,000,000
b. 4,693,000
c. 4,712,300
d. 4,723,700
5. On January 1, 2017, Christian Company issued its 5-year, 5,000, 8% bonds that will mature on December 31,
2021 and pay interest annually at 110. Christian however had to incur P80,000 of bond issue cost. The effec-
tive rate on the same date was 6%. If Christian uses the effective interest method of amortization, what is the
carrying amount of this bonds payable on December 31, 2017
a. 5,345,200
b. 5,300,000
c. 5,420,000
d. 5,375,600
PAGE 6
6. On June 30, 2017, Maury Company had outstanding 12%, P5,000,000 face value bonds maturing on June 30,
2022. Interest was payable semiannually every June 30 and December 31. On June 30, 2017, after amortiza-
tion was recorded for the period, the unamortized bond discount and bond issue costs were P500,000 and
P300,000, respectively. On that date, Maury acquired all its outstanding bonds on the open market at 96 and
retired them. At June 30, 2017, what amount should Maury recognize as loss before income tax on redemption
of bonds?
a. 600,000 c. 400,000
b. 500,000 d. 800,000
7. On December 31, 2017, Michelle Company issued 5,000 of its 12%, 10-year P1,000 face value bonds with de-
tachable stock warrants at 110. Each bond carried a non-detachable warrant for ten shares of Michelle's P100
par value ordinary shares at a specified option price of P120. Immediately after issuance, the market value of
the bonds ex-warrants was P4,800,000 and the market value of the warrants were ascertained to be
P1,200,000. For the issuance of the bonds, what amount should be the increase in shareholders equity?
a. 600,000 c. 700,000
b. 1,100,000 d. 1,200,000
8. On December 31, 2017, Armor Company issued P5,000,000 face value, 5-year bonds at 109. Each P1,000
bond was issued with 10 non-detachable stock warrants, each of which entitled the bondholder to purchase
one share of P100 par value common at P120. Immediately after the issuance, the market value of each war-
rant was P5. The stated interest rate on the bonds is 11% payable annually every December 31. However, the
prevailing market rate of interest for similar bonds without the warrants is 12%. The present value of 1 at 12%
for 5 periods is 0.57 and the present value of an ordinary annuity of 1 at 12% for 5 periods is 3.60. On Decem-
ber 31, 2017, what amount should Armor record as increase in stockholders’ equity as a result of the bond is-
suance?
a. 620,000 c. 250,000
b. 440,000 d. 0
10. Kart Company issued 4,000 convertible bonds on January 1, 2017. The bonds have a three-year term and are
issued at par with a face value of P1,000 per bond. Interest is payable annually in arrears at a nominal 6% in-
terest rate. Each bond is convertible at anytime up to maturity into 100 ordinary shares with par value of P5.
When the bonds are issued, the prevailing market interest rate for similar debt instrument without conversion
option is 9%. What is the equity component of the issuance of convertible bonds on January 1, 2017? (Round
off present value factors to two decimal places).
a. 2,000,000 c. 312,800
b. 920,000 d. 0
11. On July 1, 2017, after recording interest and amortization, Hymn Company converted P5,000,000 of its 12%
convertible bonds into 60,000 shares of P50 par value ordinary shares. On the conversion date the carrying
amount of the bonds was P6,000,000, the market value of the bonds was P6,500,000, and Hymn’s ordinary
shares was publicly trading at P150 per share. Hymn paid P300,000 in connection with the conversion and oth-
er stock issue costs. The equity component on issue date of the bonds was P800,000. What is the share pre-
mium from issuance should Hymn record as a result of the conversion?
a. 3,000,000 c. 2,000,000
b. 2,700,000 d. 3,500,000
12.On January 1, 2017, Gomez Company received P5,385,000 for a P5,000,000 face amount, 12% bond, a price
that yields 10%. The bond pays interest semiannually. The entity elected to use the fair value option for valuing
financial liabilities. On the December 31, 2017, the fair value of the bonds was determined to be P5,100,000. It
was also determined that P50,000 of the decline in fair value was because of the effect of credit risk.
1.What is the gain or loss that should be recognized in the 2017 income statement?
a. 285,000 gain c. 235,000 loss
b. 285,000 loss d. 235,000 gain
2. What is the 2017 interest expense?
a. 536,963 c. 538,500
b. 600,000 d. 646,200
ANSWERS: B, B, A, B, A, C, A, A, C, A, C, B, D, B
PAGE 7
IV. OPERATING LEASE LESSOR AND LEASEBACK
a) Lessees now must treat all leases as finance lease unless it is only 1 year or shorter and determined to be
low value items.
b) The lessor shall recognize lease or rental income using the straight-line method over the lease term.
c) If the rentals are uneven (increasing or decreasing) or there is a period where rentals are not paid. The total
amount of rentals is computed and divided equally over the lease term.
d) Contingent rentals are recognized as additional income by the lessor using the accrual method.
e) Lease bonuses or prepayments (additional lumpsum amount received at the inception or start of the lease)
should be deferred and amortized as additional rental income over the lease term.
f) Initial direct cost is capitalized as cost of the leased asset and amortized as expense over the lease term.
g) The depreciation on the asset and other expenses related to the ownership of the asset like insurance and
taxes shall be recognized as an expense by the lessor.
h) Sale and leaseback transactions are now treated differently from the side of the lessee.
• The lessee shall automatically recognize a lease liability and capitalize the “right of use asset” ac-
count for the asset sold and leased back.
• There is no problem if the selling price is at fair value. If the selling price is above fair value, the dif-
ference shall be treated as a lease incentive or additional financing and shall be deducted from the
lease liability and other components in computing for the right of use asset. If the selling price is be-
low fair value, the difference shall be treated as a lease prepayment and therefore added in compu-
ting for the cost of the right of use asset.
• The entity shall compute the “right of use retained” by dividing the cost of the asset by its fair val-
ue and the percentage of “right of use transferred” by deducting from 1 the right of use retained.
• The right of use asset to be capitalized is the total cost of the leased asset (lease liability + initial di-
rect cost + lease prepayment – lease incentive received + PV of removal cost) x right of use re-
tained.
• The TOTAL “right of use transferred” is the FV less the total cost of the “right of use asset”.
• The gain or loss on the right of use transferred is the “total right of use transferred” x percentage of
right of use transferred.
Problems
1. On January 1, 2016, Glory Company signed a 3-year operating lease for to lease office space at P3,500,000
per year. The lease included a provision for additional rent of 5% of annual company sales more than
P10,000,000. The lessee’s sales for the year ended December 31, 2016 was P15,000,000. Upon execution of
the lease, Glory paid P1,200,000 as a bonus for the lease in order to obtain a 3-year lease instead of the les-
sor’s usual lease term of 5 years. What is Glory’s total rental income for the year ended December 31, 2016?
a. 3,900,000 c. 4,150,000
b. 3,250,000 d. 3,500,000
2. As an inducement to enter a lease, Pride Company, a lessor, grants Mango Company, a lessee, six months of
free rent under a five-year operating lease. The lease is effective on July 1, 2015, and provides for monthly
rental of P250,000 to begin January 1, 2016.
1. What is the rental income for the year ended June 30, 2016?
a. 3,000,000 c. 1,200,000
b. 2,700,000 d. 1,500,000
2. What is the rental receivable for the year ended June 30, 2017?
a. 900,000 c. 600,000
b. 1,200,000 d. 300,000
3. On January 1, 2017, Resilient Company leased a building from Black Company under a 3-year operating lease.
The total rent for the lease term will be P15,600,000, payable as follows:
12 months at P300,000 P3,600,000
12 months at P400,000 4,800,000
12 months at P600,000 7,200,000
All payments were made when due. Black’s reporting date is every December 31.
1. What is the amount of rental revenue that shall be reported by Black in 2017?
a. 7,200,000 c. 2,000,000
b. 5,200,000 d. 0
PAGE 8
2. What is the rental receivable for the year ended June 30, 2018?
a. 2,000,000
b. 2,800,000
c. 1,600,000
d. 1,200,000
4. On January 1, 2016, Splash Company leased a building to Palace Company under an operating lease for three
years at P6,000,000 per year, payable the first day of each lease year. Splash paid P1,500,000 to a real estate
broker as a finder’s fee. The building is depreciated P600,000 per year. For 2016, Splash incurred property tax
expense totaling P300,000. What is the net rental income for 2016?
a. 4,600,000
b. 6,000,000
c. 5,100,000
d. 4,500,000
5. Justice Company purchased a new machine for P5,000,000 on January 1, 2016 for the purpose of leasing it.
The machine has an estimated 10-year life. On April 1, 2016, Justice leased the machine to Supremacy Com-
pany for three years at a monthly rental of P300,000. Supremacy Company paid the rental for one year of
P3,600,000 on April 1, 2016 and additionally paid P600,000 to Justice as a lease bonus to obtain the three-year
lease. On April 1, 2016, Justice incurred initial direct costs of P240,000. What is Justice’s 2016 operating profit
on this leased asset?
a. 2,290,000
b. 2,415,000
c. 2,110,000
d. 2,740,000
6. On January 1, 2017 Gladys Company sold equipment with an estimated remaining useful life of 12 years to Bub-
bles Company. At the same time, Gladys leased back the equipment for 5 years. The lease does not contain a
purchase option and the equipment will revert to Bubbles at the end of the lease term. The selling price was be-
low the fair value which is considered a lease prepayment. Additional information regarding this sale and lease-
back transaction is as follows:
Sales price 15,000,000
Fair value 16,000,000
Carrying amount 12,000,000
Lease payments in advance 2,000,000
Initial direct cost 200,000
Implicit rate 12%
PV of an ordinary annuity 3.60
PV of an annuity due 4.04
1. What is the cost of the right of use asset?
a. 6,810,000
b. 6,060,000
c. 7,010,000
d. 6,260,000
ANSWERS: C, B, A, B, A, A, A, C, C
PAGE 9
V. FINANCE LEASES – LESSEE AND LESSOR
a) Lessee:
• The lessee shall always treat the lease as a finance lease unless low value or short-term
• The lease liability is the Present Value of lease payments whether fixed or variable less lease incen-
tive receivable plus the present value of any reasonable certain purchase option or present value of
the residual value guarantee.
• If the lease payments are in advance use the PV of an annuity due if the it’s at the end of the period
use the PV of an ordinary annuity. Meanwhile the PV of 1 is used for the purchase option and resid-
ual value guarantee.
• The cost of the right of use asset is the Lease Liability + Lease prepayment + Initial Direct Cost + PV
of removal, dismantling and restoration cost minus lease incentive received.
• The discount (difference of total payments and PV) is amortized using the effective interest method
and recognized as interest expense. While the difference of the interest and payment shall be a re-
duction of the lease liability.
• The amount to be recognized as a reduction of the lease liability within 12 months shall be classified
as a current liability.
• The right of use asset shall be depreciated using the useful life if there is a transfer of ownership or
reasonable certain purchase option. If not, the useful life or lease term whichever is shorter is used.
b) Lessor:
• The lease is either a sales type lease or direct financing lease.
• Whether STL or DFL the gross investment and net investment is determined:
a. Gross investment is the total lease receivable meaning the lease payments plus reasonable cer-
tain purchase option or residual value whether guaranteed or unguaranteed.
b. Net investment is the PV of the gross investment. Under the DFL, the NI is the cost of the asset
plus the initial direct cost capitalized.
c. The difference between the GI and NI is the total financial revenue.
• If it is a sales type lease sales and cost of sales shall be recognized and the difference between the
2 is the selling profit that shall be recognized in full the period of sale.
a) Sales is the FV or PV of the minimum lease payment (lease payments + reasonable certain pur-
chase option or residual value guarantee) whichever is lower.
b) Cost of sales is the cost of the asset plus initial direct cost minus the PV of the unguaranteed
residual value.
c) The interest income is also recognized by using the effective interest method over the lease
term.
• If it is a direct financing lease, the difference of the gross investment and the cost of the asset and di-
rect cost is amortized as interest income over the lease term also under the effective interest meth-
od.
• The carrying amount of the lease receivable is equal to the PV or the net investment.
Problems
1. Viola Company leased an equipment from Walsh Company on January 1, 2016 under a lease with the following
pertinent information:
Annual rental payable at the end of each year 500,000
Lease term 7 years
Useful life of equipment 10 years
Implicit interest rate 11%
PV of an ordinary annuity of 1 for 7 periods at 11% 4.71
Present value of 1 for 7 periods at 11% 0.48
Lease prepayment 100,000
Lease incentive received 30,000
Present value of expected removal cost incurred 80,000
Viola has the option to purchase the machine on January 1, 2023 by paying P400,000 which is significantly less
than the P600,000 expected fair value of the machine on the option exercise date and is expected to be rea-
sonable exercised. On January 1, 2016, Viola incurred initial direct costs of P50,000. Viola uses the straight-
line method of depreciation for all its assets with no expected residual value.
PAGE 10
1. What is the cost of the machinery at the inception of the lease?
a. 2,547,000
b. 2,747,000
c. 2,355,000
d. 2,643,000
2. What is the balance of the lease liability on December 31, 2016?
a. 2,547,000
b. 2,047,000
c. 2,327,170
d. 2,549,170
3. What is the current portion of this lease liability on December 31, 2016?
a. 500,000
b. 244,011
c. 219,830
d. 255,989
4. What is the depreciation expense for 2016 assuming no residual value?
a. 254,700
b. 363,857
c. 274,700
d. 392,428
2. Jalen Company leased equipment for its entire nine-year useful life, agreeing to pay P1,000,000 at the start of
the lease term on January 1, 2016, and P1,000,000 annually on each January 1, for the next eight years. The
present value on January 1, 2016, of the nine lease payments over the lease term, using the rate implicit in the
lease which Jalen knows to be 10% was P6,330,000. The January 1, 2016, present value of the lease pay-
ments using Jalen’s incremental borrowing rate of 12% was P5,970,000. Jalen made a timely second lease
payment.
1. What is the balance of the finance lease liability on December 31, 2016?
a. 6,330,000
b. 5,330,000
c. 5,970,000
d. 4,970,000
2. What is the 2017 interest expense?
a. 496,300
b. 596,300
c. 486,300
d. 547,968
3. What amount should Jalen report as finance lease liability in its December 31, 2017 statement of financial
position?
a. 4,863,000
b. 5,963,000
c. 4,963,000
d. 3,863,000
3. On January 1, 2016, Colbert Company leased two automobiles for executive use. The lease requires Cobert to
make five annual payments of P2,000,000 beginning January 1, 2016. At the end of the lease term at Decem-
ber 31, 2020, Colbert guarantees the residual value of the automobiles at P500,000. The interest rate implicit in
the lease is 12% and present value factors are as follows:
For an annuity due with 5 payments 4.04
For an ordinary annuity with 5 payments 3.60
Present value of 1 for 5 periods 0.57
1. What is the finance lease liability immediately after the first required payment?
a. 6,080,000
b. 6,365,000
c. 5,485,000
d. 5,128,800
PAGE 11
2. What is the total financial revenue from the direct financing lease transaction?
a. 2,550,000
b. 1,550,000
c. 1,950,000
d. 1,200,000
ANSWERS: B, C, B, C, B, C, A, B, B, A, B, C, A, B, A, A, B, B, C, C, A, D, A, A
Problems
1. For the year ended December 31, 2016, David Company reported pretax financial income of P5,500,000. Its
taxable income was P4,000,000. The difference is due to interest income of P1,000,000 earned from govern-
ment treasury bill and an additional P500,000 charge for depreciation expense. Interest income from govern-
ment securities is subject to final tax and the accelerated depreciation for income tax purposes. The income
tax rate is 30% and David made estimated tax payments during 2016 of P900,000.
PAGE 14
1. What should David report as current tax expense for 2016?
a. 1,200,000
b. 1,350,000
c. 1,500,000
d. 1,650,000
2. In 2018, David’s pretax financial income amounted to P6,000,000 and the taxable income was P6,500,000.
The difference was due to the reversal of the taxable temporary difference in 2016. There were no perma-
nent differences in 2018. What is David’s 2018 current tax expense?
a. 1,950,000
b. 1,800,000
c. 1,500,000
d. 1,650,000
2. For the year ended December 31, 2016, Rocky Company reported pretax financial income of P6,000,000. Its
taxable income was P7,000,000. The difference is due to rental received in advance. Rental income is taxable
when received but reported in financial income when the rent is received. The income tax rate is 30% and
Rocky made estimated tax payment of P1,500,000 in 2016. There were no permanent differences in 2016.
1. What amount should Rocky report as 2016 total income tax expense?
a. 1,500,000
b. 1,650,000
c. 1,800,000
d. 2,100,000
2. In 2017, Rocky’s pretax financial income amounted to P7,500,000 and the taxable income was P6,500,000.
The difference was the inclusion of the rental income recognized in 2016 that was received and included in
taxable income in 2016. There were no permanent differences in 2017. What is Rocky’s 2017 total tax ex-
pense?
a. 2,250,000
b. 1,950,000
c. 1,650,000
d. 1,400,000
3. At December 31, 2016, Sonic Corporation’s accounting profit is P8,000,000. The following items are the tempo-
rary differences that caused Sonic’s income tax in the income tax return to differ from the amount reported in
the income statement, future deductible amounts expected to reverse in 2017 of P1,000,000 and future taxable
amounts expected to reverse in 2017 and later years of P1,200,000 and P1,800,000, respectively. Sonic’s in-
come tax rate is 30%. What amount should be reported as income tax payable on December 31, 2016, assum-
ing no taxes have been paid by Sonic?
a. 1,800,000
b. 2,400,000
c. 2,000,000
d. 1,500,000
4. Vincent Company, organized on January 1, 2016, had pretax accounting income of P5,000,000 and taxable
income of P7,000,000 for the current year. The only temporary difference is accrued product warranty cost that
is expected to be paid in 2017. The enacted tax rates are 30% for 2016 and 25% for 2017 and the years
thereafter. What amount should be reported as total income tax expense in the income statement for 2016?
a. 1,500,000
b. 2,100,000
c. 1,250,000
d. 1,600,000
5. On December 31, 2015, Briggs Company reported a deferred tax liability of P500,000 and a deferred tax asset
of P350,000. At the end of 2016, Briggs Company reported a deferred tax liability of P900,000, and a deferred
tax asset of P100,000. What is the deferred tax expense for 2016?
a. 450,000
b. 150,000
c. 300,000
d. 650,000
PAGE 15
6. Royce Company is determining the amount of pretax financial income for 2016 by making adjustments to taxa-
ble income from the 2016 tax return. The tax return indicates taxable income of P6,000,000 on which a tax lia-
bility of P1,800,000 has been recognized. The following is the list of items that may be required to determine
pretax financial income:
Tax depreciation in excess of book depreciation 1,000,000
Estimated warranty cost for 2016 2,000,000
Actual warranty cost paid in 2016 500,000
Proceeds from life insurance policy upon death of officer in 2016
received by Royce Company as the beneficiary not included
in the tax return 4,000,000
Cash dividend received but not included in the 2016 tax return
because it is from a domestic corporation 1,500,000
Interest revenue on treasury bill received but not
included in the 2016 tax return because
this revenue is subject to a final withholding tax 3,000,000
1. What was Royce Company’s pretax financial income?
a. 14,000,000
b. 8,000,000
c. 3,500,000
d. 12,000,000
2. What was Royce Company’s total tax expense?
a. 1,650,000
b. 4,200,000
c. 1,800,000
d. 1,500,000
3. What is the deferred tax expense or benefit?
a. 150,000 deferred
b. 150,000 benefit
c. 350,000 deferred
d. 350,000 benefit
ANSWERS: A, A, C, A, A, D, D, A, A, A
IFRS
a) Asset Swap – The difference between the carrying amount of the liability both principal and accrued
interest extinguished and the carrying amount of the (noncash) asset is recognized as a “gain on
extinguishment of debt”
b) Equity Swap – The equity instrument is either measured at FV of the shares (1 st priority) or FV of the
liability (2nd priority). The difference between the FV (shares or liability) and par value of the shares as
share premium and the difference of the carrying amount of the liability and FV as a “gain on
extinguishment of debt”. If both FV is not determinable, the difference between the CA of the liability and
par value of the shares is recognized as share premium, there is no gain to be recognized.
c) Modification of terms – The principal, interest rate, maturity date and accrued interest owed is modified.
The PV of the modified cash flows (original effective rate is used) and the carrying amount of the liability,
principal and interest is recognized as either a gain or loss on extinguishment of debt if the difference is at
least 10% (materiality test) of the original liability.
d) Future interest expense is computed using the effective interest method. The difference between the
interest expense and interest paid is amortization of the discount.
PAGE 16
US GAAP
a) Asset Swap – The difference between the carrying amount of the asset and the FV of the asset is
recognized as a “gain on sale” (as if sold approach). The difference of the FV (assumed to be proceeds
from sale) and the principal and accrued interest extinguished is recognized as a “gain on debt
restructuring”
b) Equity Swap – SAME AS IFRS
c) Modification of terms – The absolute amount of modified future cash flows is compared to the principal
and present accrued interest. If there is a gain it is recognized, if there is a loss it is ignored. The future
interest is included in the face value of the new liability, therefore no or ZERO future interest expense is
recognized.
Problems
1. David Company is indebted to Mercury Company under a P5,000,000, 10% three-year note dated December
31, 2013. Because of financial difficulties, David owed accrued interest of P500,000 on the note at December
31, 2016. Under a debt restructuring on December 31, 2016, Mercury Company agreed to settle the note and
accrued interest for a tract of land having a fair value of P3,500,000. The acquisition cost of the land is
P2,000,000. What is the gain on extinguishment of debt in the 2016 income statement of David?
a. 2,000,000
b. 2,500,000
c. 4,500,000
d. 3,500,000
2. On December 31, 2016, Cardinal Company shows the following data with respect to its maturing obligation:
Note payable 6,000,000
Accrued interest payable 600,000
The company is threatened with a court suit if it could not pay its maturing debt. Accordingly, the company en-
ters into an agreement with the creditor for the issuance of ordinary shares in full settlement of the note paya-
ble. The agreement provides for the issue of 50,000 shares of ordinary shares with par value of P100. The or-
dinary shares are currently quoted at P110 per share. How much is the gain on extinguishment of debt that
Cardinal will recognize in its 2016 income statement from the “equity swap”?
a. 1,600,000
b. 1,100,000
c. 500,000
d. 0
3. Due to adverse economic circumstances and poor management, Manchester Company has negotiated a re-
structuring of its P5,000,000 note payable to Germany Bank. Germany Bank has agreed to reduce the face
value of the note from P5,000,000 to P4,000,000, reduce the interest rate from 14% to 10%, and extend the
due date two years from the date of restructuring. The restructuring will occur on December 31, 2016, the last
day of Manchester’ annual reporting period. The unpaid interest on the restructured loan now is P700,000
which is forgiven. What is the gain on the debt restructuring under US GAAP?
a. 1,700,000
b. 1,000,000
c. 700,000
d. 900,000
4. Due to extreme financial difficulties, Amsterdam Company has negotiated a restructuring of its 12%,
P8,000,000 note payable due on December 31, 2016. The unpaid interest on the note on such date is
P1,500,000. The creditor has agreed to reduce the face value to P7,000,000, forgive the unpaid interest, re-
duce the interest rate to 10% and extend the due date three years from December 31, 2016. The present value
of 1 at 12% for three periods is 0.712 and the present value of an ordinary annuity of 1 at 12% for three periods
is 2.40. What should Amsterdam Company report in 2016 as a gain on extinguishment of debt?
a. 2,836,000
b. 2,500,000
c. 1,000,000
d. 1,500,000
ANSWERS: D, B, D, A
PAGE 17
The service cost and net interest are included in profit or loss as employee benefit expense, while the remeas-
urement gain or loss at net or in total are fully recognized through other comprehensive income.
c) Current Service Cost - Present Value of Post-employment benefits (earned by employees) incurred by
the employer resulting from employee services in the current period. Component of benefit expense (pen-
sion cost) and increases the Projected Benefit Obligation (PBO)
d) Interest Expense - Amortization of the DISCOUNT on the beginning balance of the PBO. FORMULA: Be-
ginning Balance of PBO time the settlement discount rate. The settlement discount rate is the rate used by
the ACTUARY to compute for the present value of the post-employment benefits to be paid in the future.
Component of benefit expense and increases the PBO.
e) Past Service Cost - Is the increase in the present value of the defined benefit obligation for employee ser-
vice in prior periods, resulting in the current period from the introduction of, or changes to, post-
employment benefits or “curtailment”. Included as benefit expense whether vested or not vested. Vested
benefits are employee benefits that are not conditional on future employment.
f) Actual return on Plan Assets - Income on the plan assets in the form of dividends, interest, and gains on
sale. May either increase or decrease the Fair Value of Plan Assets because sometimes the return might
be a loss (decrease)
g) Interest Income - Replaces the “expected return” under the old standard as the deduction from benefit ex-
pense and is compared with the “actual return” in computing for the gain or loss on plan assets as part of
remeasurements. FORMULA: Beginning FVPA times the Settlement discount rate.
h) Gain or loss on Settlement - Difference between the settlement price paid to retirees and the present
value of the defined benefit obligation that is eliminated on the date of settlement.
i) Surplus - FVPA exceeds the PBO hence a debit balance in the prepaid accrued benefit cost account is
presented in the statement of financial position.
j) Asset Ceiling - The limitation to the amount to be presented as surplus in the statement of financial posi-
tion. Present value of any economic benefits available in the from of refunds from the plan or reductions in
future contributions to the plan.
PAGE 18
k) “Effect of asset ceiling” - Is the reduction in the surplus that will be presented in the statement of financial
position.
FORMULAS
• CSC, PSC & IC (–) Interest income + Settlement loss (-) Settlement Gain + Interest
Benefit Expense
on Beginning effect of asset ceiling
• Beginning + CSC, PSC & IC (-) Benefits paid and PV settled +/(-) Inc. or Dec. in
PBO
PBO = Ending
• Beginning + Employer Contributions – Benefits paid and Settlement Price +/(-) Ac-
FVPA
tual return = Ending
1. Kristaps Company provided the following data in its memorandum records for a defined benefit plan on Janu-
ary 1, 2017, prior to applying PAS 19R.
What is the balance of the prepaid/accrued benefit cost to be shown in the balance sheet as either a noncurrent
asset or a noncurrent liability by Kristaps after applying the provisions of PAS 19R?
a. 3,000,000 prepaid
b. 3,000,000 accrued
c. 4,000,000 prepaid
d. 4,000,000 accrued
P2. On January 1, 2017, Klein Company provided the following data in connection with its defined benefit plan:
Fair value of plan assets 10,000,000
Projected benefit obligation 13,000,000
Prepaid /accrued benefit cost ( 3,000,000)
The accountant revealed the following information affecting the plan in 2017:
Current service cost 2,500,000
Past service cost – remaining vesting period of
employees covered by the plan is 5 years 1,000,000
Contribution to the plan 3,500,000
Benefits paid to retirees 3,000,000
Actual return on plan assets 1,500,000
Decrease in projected benefit obligation due to
changes in actuarial assumptions 400,000
Expected rate of return on plan assets 12%
Settlement discount interest rate 10%
PAGE 19
1. What is the 2017 total employee benefit expense?
a. 4,800,000
b. 3,000,000
c. 3,800,000
d. 3,600,000
2. What is the remeasurement gain to be recognized in other comprehensive income in 2017?
a. 900,000
b. 800,000
c. 400,000
d. 100,000
3. What is the total or net defined benefit cost for 2017?
a. 3,800,000
b. 4,700,000
c. 2,900,000
d. 3,500,000
4. What is the fair value of plan assets on December 31, 2017?
a. 12,000,000
b. 15,000,000
c. 11,700,000
d. 10,500,000
5. What is the projected benefit obligation on December 31, 2017?
a. 14,400,000
b. 15,200,000
c. 17,800,000
d. 13,400,000
6. What is the balance of the prepaid/accrued cost account on December 31, 2017?
a. 2,400,000 accrued
b. 3,300,000 prepaid
c. 2,400,000 prepaid
d. 3,300,000 accrued
3. Jordan Company provided the following data in its memorandum records for a defined benefit plan on Janu-
ary 1, 2017.
Fair value of plan assets 7,000,000
Projected benefit obligation (8,000,000)
Prepaid/accrued benefit cost (1,000,000)
The transactions affecting the defined benefit plan for the current year are as follows:
Current service cost 1,400,000
Past service cost 500,000
Contribution to the plan 1,200,000
Benefits paid to retirees 1,500,000
Actual return on plan assets 600,000
Increase in projected benefit obligation due to changes
in actuarial assumptions 300,000
Present value of benefit obligation settled 1,000,000
Settlement price of benefit obligation 800,000
Discount rate 10%
Expected rate of return 15%
1. What is the 2017 total employee benefit expense?
a. 2,700,000 c. 1,800,000
b. 2,200,000 d. 2,000,000
2. What is the net remeasurement gain or loss to be recognized in 2017?
a. 400,000 loss c. 200,000 loss
b. 400,000 gain d. 200,000 gain
PAGE 20
3. What is the total or net defined benefit cost for 2017?
a. 2,000,000 c. 2,200,000
b. 2,300,000 d. 1,400,000
4. Mandy Company provided the following information regarding its defined benefit plan during 2017. Balances
on January 1, 2017 are:
Fair value of plan assets 6,000,000
Projected benefit obligation 5,000,000
Prepaid/accrued benefit cost - surplus 1,000,000
Asset ceiling* 700,000
Effect of asset ceiling 300,000
The asset ceiling is the present value of the economic benefits available in the form of refunds and reductions
in future contributions to the plan and is considered in reporting the amount of surplus in the balance sheet.
Therefore, the December 31, 2016 statement of financial position reported a prepaid accrued benefit cost of on-
ly P700,000 as a noncurrent asset. The asset ceiling computed on December 31, 2017 amounted to
P1,200,000.
During the current year, the entity recognized current service cost of P700,000, past service cost of P200,000,
actual return on plan assets of P900,000, a decrease in the PBO of P500,000 due to changes in actuarial as-
sumptions and contribution to the plan of P1,000,000. The discount rate is 10%.
1. What is the employee benefit expense for the current year?
a. 900,000 c. 830,000
b. 870,000 d. 800,000
2. What is the net remeasurement gain or loss in 2017?
a. 400,000 loss c. 800,000 gain
b. 470,000 loss d. 330,000 gain
5. Hero Company reported a prepaid benefit cost of 1,500,000 on January 1, 2017. The following information re-
lated to Hero’s defined benefit plan are as follows:
Service cost 3,000,000
Actual return on plan assets 1,200,000
Interest expense 800,000
Settlement price 500,000
Excess of actual return 200,000
Actuarial gain on PBO 400,000
Gain on settlement 100,000
Past service cost 500,000
Benefits paid to retirees 2,500,000
Increase in asset ceiling 500,000
Contribution 4,000,000
Projected benefit obligation 1/1 8,000,000
1. What is the 2017 benefit expense?
a. 3,250,000 c. 3,300,000
b. 3,350,000 d. 3,000,000
2. What is the 2017 defined benefit cost?
a. 3,200,000 c. 3,500,000
b. 3,250,000 d. 2,750,000
3. What is the prepaid benefit cost on December 31, 2017?
a. 1,400,000 c. 1,000,000
b. 2,000,000 d. 1,600,000
ANSWERS: B,C,A,C,A,A,C,C,A,C,C,D,A,C,B
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