AUDIT OF LIABILITIES

PROBLEM 1

BOOMERANG, INC. is a manufacturer and retailer of household furniture. Your audit of the
company’s financial statements for the year ended December 31, 2016, discloses the following debt
obligations of the company at the end of its reporting period. Boomerang’s financial statements are
authorized for issuance on March 6, 2017.

1. A P150,000 short-term obligation due on March 1, 2017. Its maturity could be extended to March 1,
2019, provided additional collateral. On February 12, 2017, an agreement is reached to extend the
loan’s maturity to March 1, 2019.

2. A short-term obligation of P3,600,000 in the form of notes payable due February 5, 2017. The
company issued 75,000 ordinary shares for P36 per share on January 25, 2017. The proceeds from the
issuance, plus P900,000 cash, were used to fully settle the debt on February 5, 2017.

3. A long-term, obligation of P2,500,000 due December 1, 2026. On November 10, 2016. On November
10, 2016, Boomerang breaches a covenant on its debt obligation and the loan becomes payable on
demand. An agreement is reached to provide a waiver of the breach on December 11, 2016.

4. A long-term obligation of P4,000,000. The loan is maturing over 4 years in the amount of P1,000,000
per year. The loan is dated September 1, 2016, and the first maturity date is September 1, 2017.

5. A debt obligation of P1,000,000 maturing on December 1, 2019. The debt is callable on demand by
the lender at any time.

QUESTIONS:

1. What amount of current liabilities should be reported on the December 31, 2016, statement of
financial position?
A. P8,250,000 C. P4,750,000
B. P5,750,000 D. P3,750,000

2. What amount of noncurrent liabilities should be reported on the December 31, 2016, statement of
financial position?
A. P5,500,000 C. P6,500,000
B. P3,000,000 D. P7,500,000

PROBLEM 2

ANGLIN CORPORATION must determine the December 31, 2016 year-end accruals for advertising and
rent expenses. A P50,000 advertising bill was received January 10, 2017, comprising costs of P37,500 for
advertisements in December 2016 issues, and P12,500 for advertisements in January 2017 issues of the
newspaper.

A store lease, effective December 16, 2015, calls for fixed rent of P120,000 per month, payable one month from
the effective date and monthly thereafter. In addition, rent equal to 5% of net sales overP6,000,000 per calendar
year is payable on January 31, of the following year. Net sales for 2016 were P7,500,000.

Question: What are the total accrued liabilities that should be reported by Anglin Corporation in its statement of
financial position as at December 31, 2017?

A. P185,000 C. P97,500
B. P172.500 D. P110,000

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PROBLEM 3

In packages of its products, PLACID, INC. includes coupons that may be presented at retail stores to
obtain discounts on other Placid products. Retailers are reimbursed for the face amount of coupons
redeemed plus 10% of that amount for handling costs. Placid honors requests for coupon redemption by
retailers up to 3 months after the consumer expiration date. Placid estimates that 60% of all coupons
issued will ultimately be redeemed. Information relating to coupons issued by Placid during 2016 is as
follows:

Consumer expiration date Dec. 31, 2015

Total payments to retailers as of Dec. 31, 2016 P165,000
Liability for unredeemed coupons as of Dec. 31, 2016 P 99,000

Question: What is the total face amount of coupons issued by Placid, Inc. in 2016?
A. P440,000 C. P600,000
B. P400,000 D. P264,000

PROBLEM 4

OMEGA COMPANY sells its products in expensive, reusable containers. The customer is charged a
deposit for each container delivered and receives a refund for each container returned within two years
after the year of delivery. Omega accounts for the containers not returned within the time limit as being
sold at the deposit amount. Information for 2016 as follows:

Containers held by customers at

December 31, 2015
from deliveries in: 2014 85,000
2015 240,000 325,000
Containers delivered in 2016 ` 430,000
Containers returned in 2016
from deliveries in: 2014 57,500
2015 140,000
2016 157,000 354,500

Question 1: How much revenue from container sales should be recognized for 2016?
A. P127,500 C. P27,500
B. P267,500 D. P85,000

Question 2: What is the total amount of Omega Company’s liability for returnable containers at December 31,
2016?
A. P373,000 C. P267,500
B. P400,500 D. P430,000

PROBLEM 5

Described below are certain transactions of ASHBY COMPANY:

Feb. 2 The company purchased goods from Happy Corp. for P150,000 subject to cash discount terms
of 2/10, n/30. The company records purchase and accounts payable at net amounts after cash
discounts. The invoice was paid on February 25.

April 1 The company purchased a truck for P120,000 from Broom Motors Corp., paying P12,000 in cash
And signing a one-year, 12% note for the balance of the purchase price.

May 1 The company borrowed P240,000 from Manila Bank by signing a P276,000 noninterest bearing
note due one year from May 1.

Aug. 1 The company’s board of directors declared a P900,000 cash dividend that was payable on Sept.
10 to shareholders of record on August 31.

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 1. Prepare all the journal entries necessary to record the transactions described above.

2. Assume that Ashby Company’s financial year ends on December 31 and that no adjusting entries
relative to the transactions above have been recorded. Prepare any adjusting journal entries
concerning interest that are necessary to present fair financial statements at December 31.

Presented below are two independent situations. Answer the questions at the end of each situation.

PROBLEM 6

BARRADO CO, a machinery dealer, sells a machine for P22,200 under a 1-year warranty contract that requires
the company to replace all defective parts and to provide the necessary repair labor at no cost to the customers.
With sales being made evenly throughout the year, Barrado sells for each 600 machines in 2016 (half of the
warranty expense is incurred in 2016, half in 2017). On the basis of experience, the 1-year warranty costs are
estimated to be P510 parts and P660 labor. Assume that in 2016, these warranty costs are incurred exactly as
estimated.

1. What amount of warranty expense would be charged against 2016 revenue?

A. P702,000 C. P153,000
B. P351,000 D. P396,000

2. What amount of warranty liability would appear on the December 31, 2016, statement of financial
position?
A. P 0 C. P702,000
B. P153,000 D. P351,000

PROBLEM 7

DP INC., a dealer of household appliances, sells washing machines at an average price f P8,100. The company
also offers to each customer a separate 3-year warranty contract for P810 that requires the company to provide
periodic maintenance services and to replace defective parts.

During 2016, DP sold 300 washing machines and 270 warranty contracts for cash. The company estimates that
the warranty costs are P180 for parts and P360 for labor.

Assume sales occurred on December 31, 2016. DP’s policy is to recognize income from the warranties on a
straight-line basis. In 2017, DP incurred actual costs relative to 2016 warranty sales of P18,000 for parts and
P35,000 for labor.

1. What liability relative to these transactions would appear on the December 31, 2016, statement of
financial position and how would it be classified?

Current Noncurrent
A P145, 800 P72,900
B P 72,900 P72,900
C P 72,900 P145,800
D P 0 P218,700

2. What amount of warranty expense would be shown on the income statement for the year ended
December 31, 2017?
A. P18.000 C. P36,000
B. P 0 D. P54,000

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 3. What liability relative to the 2016 warranties would appear on the December 31, 2017, statement of
financial position and how would it be classified?

Current Noncurrent
A P145, 800 P72,900
B P 72,900 P72,900
C P 72,900 P145,800
D P145,800 P 0

PROBLEM 8

OHRID COMPANY purchased machinery on December 31, 2016, paying P80,000 down and agreeing to
pay the balance in four equal installments of P60,000 payable each December 31. Implicit in the purchase
price is an assumed interest of 12%.

The following data are abstracted from the present value tables:

Present value of 1 at 12% for 4 periods 0.63552

Present value of an ordinary annuity of 1 at 12% for 4 periods 3.03735

1. What is the cost of the machinery purchased on December 31, 2016?

A. P233,083 C. P262,241
B. P320,000 D. 290,842

2. How much interest expense should be reported in Ohrid’s income statement for the year ended
December 31, 2017?
A. P38,131 C. P17,293
B. P21,869 D. P42,707

3. What is the carrying value of the note at December 31, 2018?

A. P120,000 C. P99,310
B. P144,110 D. P101,403

PROBLEM 9

Described below are certain transactions of TUNIS COMPANY.

1. On April 1, the corporation bought a truck for P400,000 from General Motors Company, paying
P40,000 in cash and signing a one-year, 12% note for the balance of the purchase price.

2. On May 1, the corporation borrowed P800,000 from Prudent Bank by signing a P920,000 non-interest-
bearing note due one year from May 1.

Prepare any adjusting journal entries to present fair financial statements at December 31.

PROBLEM 10

You are engaged to audit the December 31, 2016, financial statements of MILANI COMPANY, a
manufacturer of household appliances. Your audit disclosed the following situations:

1. In June 2016, the company began producing and selling a new line of dishwasher. By the end of
the year, it had sold 120,000 to various dealers for P15,000 each. The product was sold under a 1-
year warranty, and the company estimates warranty costs to be P750 per dishwasher. Milani had
paid out P30 million in warranty expenses as of December 31, 2016, which is also the amount
shown as warranty expense in its income statement for the current year.

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 2. In response to your letter of audit inquiry, Milani’s lawyer informed you that the company is
involved in a lawsuit for violating environmental laws regulating hazardous waste. Although the
litigation is pending, Milani’s lawyer is certain that Milani will most probably have to pay cleanup
costs and fines of P5,500,000. Milani neither accrued nor disclosed this loss in the financial
statements.

3. Milani is the defendant in a patent infringement suit by Megan Yang over Milani’s use of a
hydraulic compressor in several of its manufactured appliances. Milani’s lawyer informed you
that if the suit goes against your audit client, the loss may be as much as P10 million . However,
the lawyer believes that the loss of this suit is only possible. Milani did not in any way disclose
this pending litigation in its financial statements.

1. What amount of warranty expense should be shown on Milani’s income statement for the year
ended December 31, 2016?
A. P30,000,000 C. P60,000,000
B. P 0 D. P90,000,000

2. What amount of warranty liability should be shown on Milani’s statement of financial position as
of December 31, 2016?
A. P60,000,000 C. P30,000,000
B. P90,000,000 D. P 0

3. What amount of lawsuit liability should be reported as a provision on Milani’s December 31,
2016, statement of financial position?
A. P10,000,000 C. P15,500,000
B. P5,500,000 D. P 0

PROBLEM 11

On November 1, 2016, 69 passengers on CANYON AIRLINES Flight No. 143 were injured upon landing
when the plane skidded off the runway. Personal injury suits for damages totaling P10,000,000 were filed
on January 12, 2017, against the airline by 21 injured passengers. The airline carries no insurance. Legal
counsel has studied each suit and advised Canyon that it can reasonably expect to pay 70% of the
damages claimed. The financial statements for the year ended December 31, 2016, were authorized for
issue on February 12, 2017. During the past decade, the company has experienced at least one accident
per year and incurred average damages of P4,100,000.

1. Prepare the journal entry that should be made as of December 31, 2016, to recognize the loss.

2. What liability due to the risk of loss from lack of insurance coverage should Canyon Airlines record or
disclose? (Ignore the November 1, 2016, accident).

PROBLEM 12

NAKURU CORPORATION is having financial difficulty and therefore has asked Naawa Bank to
restructure its P3 million note outstanding. The present note has 3 years remaining and pays a current
rate of interest of 12%. The note was issued at its face value.

Presented below are two independent situations. Prepare the journal entry that Nakuru would make for each of
the following types of debt restructuring.
A. Naawa Bank agrees to accept land in exchange for relinquishing its claim on this note. The land
has a book value of P2,000,000 and a fair value of P2,500,000.

B. Naawa Bank agrees to reduce the principal balance due to P2,000,000 and interest rate to 10%.

The following present value factors are abstracted from the present value tables.

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 12% 10%
Present value of 1 for 3 periods 0.71178 0.75132
Present value of an ordinary annuity of 1 for 3 periods 2.40183 2.48685

PROBLEM 13

At December 31, 2016. KISU COMPANY’s liabilities include the following:

1. P10 million of 10% notes are due on March 31, 2021. The financing agreement contains a covenant
that requires Kisu to maintain current assets at least equal to 200% of its current liabilities. As of
December 31, 2016, Kisu has breached this loan covenant. On February 10, 2017, before Kisu’s
financial statements are authorized for issue, Kisu obtained a period of grace from Mayumi Bank until
January 31, 2018, having convinced the bank that the company’s normal 3 to 1 ratio of current assets to
current liabilities.

2. P15 million of noncancelable 12% bonds were issued at face value on September 10, 1995. The bonds
mature on August 31, 2017. Kisu expects to have sufficient cash available to redeem the bonds at
maturity.

3. P20 million of 10% bonds were issued at face value on June 30, 1997. The bonds mature on June 20
2026, but bondholders have the option to call (demand payment on) the bonds on June 30 2017.
However, the call option is not expected to be exercised, given prevailing market conditions.

What portion of Kisu Company’s debt should be reported as a noncurrent liability?

A. P10 million C. P20 million
B. P30 million D. P 0

PROBLEM 14

Your audit client, CHALA COMPANY, is involved in the situations described below, Chala’s accounting
year ends on December 31, 2016, and its financial statements are authorized for issue on March 20m,
2017.

1. Chala is involved in a lawsuit resulting from a dispute with a customer. On January 28, 2017,
judgment was rendered against Chala in the amount of P20 million. Chala plans to appeal the
judgment and is unable to predict its outcome though management believes that it will not have a
material adverse effect on the company.

2. On April 25, 2017, the Bureau of Internal Revenue (BIR) is in the process of examining Chala’s tax
returns for 2014 and 2015,but has not proposed a deficiency assessment. Management feels an
assessment is reasonable possible, and if an assessment is made, an unfavorable settlement of up to P5
million is reasonably possible.

3. On January 5, 2017, inventory purchased FOB shipping point from a foreign country border because of
political unrest. The shipment is valued at P1 million. Chala’s lawyers have stated that it is probable
that Chala will be able to obtain the shipment.

4. On November 1, 2016, a lawsuit was filed by a disgruntled customer who discovered a safety hazard in
one of Chala’s best-selling products. Chala’s lawyers feel it is probable that the company will be liable
for P500,000.

5. On December 5, 2016, Chala initiated a lawsuit seeking P1 million in damages from a patent
infringement.

Determine the appropriate means of reporting each situation. Prepare any necessary journal entries on
December 31, 2016.

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PROBLEM 15

LARIO COMPANY issued 10-year bonds on January 1, 2016. The company’s year-end is December 31,
and financial statements are prepared annually. The amortization and interest schedule below reflect the
bond issuance and the subsequent interest payments and charges.

AMORTIZATION SCHEDULE

Interest Interest Amount Carrying

Date Paid Expense Unamortized Value
01/31/16 -- -- P28,253 P471,747
12/31/16 P55,000 P56,610 26,643 473,357
12/31/17 55,000 56,803 24,840 475,160
`12/31/18 55,000 57,019 22,821 477,179
12/31/19 55,000 57,261 20,560 479,440
12/31/20 55,000 57,533 18,027 481,973
12/31/21 55,000 57,837 15,190 484,810
12/31/22 55,000 58,177 12,013 487,987
12/31/23 55,000 58,558 8,455 491,545
12/31/24 55,000 58,985 4,470 495,530
12/31/25 55,000 59,470* -- 500,000

*Adjustment due to rounding.

1. The bonds were issued at

A. A premium C. Face value
B. A discount D. Par value

2. What amortization method is used in the amortization schedule presented?

A. Straight-line method C. Effective interest method
B. Bonds outstanding method D. Declining balance method

3. What is the nominal (stated) interest rate of the bonds issued on January 1, 2016?
A. 11% C. 10%
B. 12% D. 6%

4. What is the effective interest rate of the bonds issued on January 1, 2016?
A. 11% C. 10%
B. 12% D. 6%

5. On the basis of the schedule presented, what is the journal entry to record the issuance of the bonds
on January 1, 2016?
A. Cash 500,00
Bonds payable 500,000
B. Cash 471,747
Interest expense 28,253
Bonds payable 500,000
C. Cash 500,000
Premium on bonds payable 28,253
Bonds payable 471,747
D. Cash 471,747
Discount on bonds payable 28,253
Bonds payable 500,000

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PROBLEM 16

The following data pertain to the CARROLL COMPANY.

1. At December 31, 2016, the company has a P900,000 liability reported for estimated litigation claims.
This P900,000 balance represents amounts that have been charged to income but are not tax deductible
until they are paid. The company expects to pay the claims and thus have tax-deductible amounts in
the future in the following manner:

YEAR PAYMENTS
2019 P150,000
2020 690,000
2021 60,000
TOTAL P900,000

2. The company uses different depreciation methods for financial reporting and tax purposes.
Consequently, at December 31, 2016, the company has a cumulative temporary difference due to
depreciable property of P2,400,000. This P2,400,000 cumulative temporary difference is to result in
taxable amounts in future years in the following manner:

YEAR PAYMENTS
2017 P480,000
2018 480,000
2019 480,000
2020 480,000
2021 480,000

3. The income tax rate is 30%.

4. Taxable income for 2016 is P2,400,000. The company expects to report taxable income for the next
five years.

5. No temporary differences existed at the end of 2015.

1. The deferred tax liability to be reported in Carroll’s statement of financial position at December
31, 2016, is
A. P720,000 C. P450,000
B. P480,000 D. 270,000

2. The deferred tax asset to be reported in Caroll’s statement of financial position at December 31,
2016, is
A. P270,000 C. P450,000
B. P150,000 D. P720,000

3. The amount of current income tax payable to be reported in Caroll’s statement of financial position
at December 31, 2016, is
A. P630,000 C. P540,000
B. P546,000 D. P720,000

4. Caroll’s pretax accounting income for 2016 is

A. P3,900,000 C. P2,874,000
B. P900,000 D. P2,400,000

5. Caroll’s net income for 2016 is

A. P2,730,000 C.. P1,230,000
B. P3,630,000 D. P4,350,000

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PROBLEM 17

On December 31, 2015, LEMAN CO. signs a 10-year noncancelable lease agreement to lease agreement to
lease a storage building from Storage Company.

The following information pertains to this lease agreement:

1. The agreement requires equal rental payments of P720,000 beginning on December 31, 2015.

2. The fair value of the building on December 31, 2015, is P4,400,000.

3. The building has an estimated economic life of 12 years, with an unguaranteed residual value of
P100,000. Leman depreciates similar buildings on the straight-line method.

4. The lease is nonrenewable. At the termination of the lease, the building reverts to the lessor.

5. The interest rate implicit in the lease is 12% per year.

6. The yearly rental payment includes P24,705 of executor costs related to taxes on the property.

The following present value factors are for 10 periods at 12% annual interest rate:

Present value of an annuity due of 1 6.32825

Present value of an ordinary annuity of 1 5.65022
Present value of 1 0.32197

1. What amount should be capitalized as the cost of the leased storage building?
A. P4,556,340 C. P4,432,197
B. P4,400,000 D. P 0

2. What amount should be included in the current liabilities section of Leman’s statement of financial
position at December 31, 2016?
A. P720,000 C. P695,295
B. P414,477 D. P280,818

3. What amount should be included in the noncurrent liabilities section of Leman’s statement of
financial position at December 31, 2016?
A. P3,453,975 C. P5,562,360
B. P3,173,157 D. P 0

4. What is the total lease-related expenses to be reported in Leman’s income statement for the year
ended December 31, 2016?
A. P909,270 C. P1,160,000
B. P879,182 D. P464,705

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