PROBLEM 1

An entity had the following financial statement elements for which the December 31, 200A carrying amount is
different from the December 31, 200A tax basis:

Carrying amount Tax basis Difference

Equipment 5,500,000 4,000,000 1,500,000

Accrued liability – health care 500,000 0 500,000
Computer software cost 2,000,000 0 2,000,000

The difference between the carrying amount and tax basis of the equipment is due to accelerated depreciation for
tax purposes.

The accrued liability is the estimated health care cost that was recognized as expense in 200A but deductible for
tax purposes when actually paid.

In January 200A, the entity incurred P3,000,000 of computer software cost. Considering the technical feasibility
of the project, this cost was capitalized and amortized over 3 years for accounting purposes. However, the total
amount was expensed in 200A for tax purposes.

The pretax accounting income for 200A is P15,000,000. The income tax rate is 30% and there are no deferred taxes
on January 1, 200A.

1. What amount should be reported as current tax expense for 200A?

a. 5,400,000
b. 3,600,000
c. 3,300,000
d. 5,700,000

2. What amount should be reported as total tax expense for 200A?

a. 4,500,000
b. 4,950,000
c. 4,050,000
d. 3,900,000

3. What amount should be reported as deferred tax liability on December 31, 200A?

a. 1,050,000
b. 1,200,000
c. 900,000
d. 150,000

4. What amount should be reported as deferred tax asset on December 31, 200A?
.
a. 750,000
b. 600,000
c. 150,000
d. 0

B – A – A C
SOLUTION – PROBLEM 3

Question 1 Answer B

Accounting income 15,000,000

Future taxable amount:
Equipment
Computer software (1,500,000)
Future deductible amount: (2,000,000)
Accrued liability 500,000
Taxable income 12,000,000

Current tax expense (30% x 12,000,000) 3,600,000

Question 2 Answer A

Total tax expense (30% x 15,000,000) 4,500,000

Question 3 Answer A

Deferred tax liability (30% x 3,500,000) 1,050,000

Question 4 Answer C

Deferred tax asset (30% x 500,000) 150,000

PROBLEM 2

On January 2, 2005, the Mauban, Inc. issued P2,000,000 of 8% convertible bonds at par. The bonds will mature on
January 1, 2009 and interest is payable annually every January 1. The bond contract entitles the bondholders to
receive 6 shares of P100 par value common stock 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 December 31, 2006, the holders of the bonds with total face value of P1,000,000 exercised their conversion
privilege. In addition, the company reacquired at 110, bonds with a face value of P500,000.

The balances in the capital accounts as of December 31, 2005 were:

Common stock, P100 par, authorized 50,000 shares,

issued and outstanding, 30,000 shares
P3,000,000

Premium on common stock 500,000

Market value of the common stock and bonds were as follows:

Date Bonds Common stock

January 1, 2006 118 40

December 31, 2006 110 42

QUESTIONS:

Based on the above and the result of your audit, answer the following: (Round off present value factors to 4
decimal places)

5. How much of the proceeds from the issuance of convertible bonds should be allocated to equity?

a. P634,000 c. P126,816

b. P221,664 d. P 0

6. How much is the carrying value of the bonds payable as of December 31, 2005?

a. P2,000,000 c. P1,389,400

b. P1,796,170 d. P1,900,502
7. How much is the interest expense for the year 2006?

a. P160,000 c. P138,940

b. P179,617 d. P190,050

8. The conversion of the bonds on December 31, 2006 will increase equity by

a. P365,276 c. P400,000

b. P307,893 d. P 0

9. How much is the loss on bond reacquisition on December 31, 2006?

a. P50,000 c. P96,053

b. P67,362 d. P 0

C – D – D – A – B

Suggested Solution:

Question No. 1

Total proceeds P2,000,000

Less liability component:

Present value of the principal

(P2,000,000 x 0.6830)
P1,366,000

Present value of the interest

[(P2,000,000 x 8% x 3.1699)
507,184 1,873,184

Equity component P 126,816

PAS 32 par. 29 states that an entity recognizes separately the 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 and liability components, the equity component 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

Carrying value, 1/2/05 (see no. 1) P1,873,184

Add discount amortization for 2005:

Effective interest (P1,873,184 x 10%) P187,318

Nominal interest (P2,000,000 x 8%) 160,000 27,318

Carrying value, 12/31/05 P1,900,502

Question No. 3

Effective interest (P1,900,502 x 10%) P190,050

Question No. 4

Journal entry to record the conversion

Bonds Payable P1,000,000

Discount on bonds payable
(P1,000,000 - P965,276) P 34,724
Common stock 600,000
APIC 365,276

Carrying amount of bonds converted (P1,930,552* x 1/2) P965,276

Less par value of common stock received

(P1,000,000/P1,000 x 6 x P100)
600,000

Amount to be credited to APIC P365,276

Carrying value, 1/1/06 (see no. 2) P1,900,502

Add discount amortization for 2006:

Effective interest (P1,900,502 x 10%) P190,050

Nominal interest (P2,000,000 x 8%) 160,000 30,050

Carrying value, 12/31/06 P1,930,552*

Question No. 5

Reacquisiton price (P500,000 x 110%) P550,000

Carrying value of bonds reacquired (P1,930,552 x 1/4) 482,638

Loss on early retirement of bonds P 67,362

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

PROBLEM 3
10. Lehman Company purchased a machine on January 1, 2012 for P2,000,000. The machine has an estimated 5-year life
with no residual value. The straight line method of depreciation is used for financial statement purposes and
the following accelerated depreciation amounts will be deducted for tax purposes:

2012 400,000 2015 230,000

2013 640,000 2016 230,000

2014 384,000 2017 116,000

The income tax rate is 30% for all years. What amount of noncurrent deferred tax liability should be reported on
December 31, 2013?

a. 72,000
b. 67,200
c. 4,800
d. 0

Suggested Solution:

(2,000,000 / 5 years) x 2 = 800,000

400,000 + 640,000 = 1,040,000

1,040,000 – 800,000 = 240,000

240,000 x 30% = 72,000

PROBLEM 4

11. In 2013, Krause Company accrued for financial reporting estimated loss on disposal of unused plant facility
of P1,500,000. The facility was sold in March 2014 and a P1,500,000 loss was recognized for tax purposes. Also
in 2013, the entity paid P100,000 in fines for violation of environmental regulations. The enacted tax rate
is 30% in both 2013 and 2014. The entity paid P780,000 in income taxes in 2013. What amount should be reported
as deferred tax asset or liability on December 31, 2013?

a. 420,000 asset
b. 360,000 asset
c. 360,000 liability
d. 450,000 asset

1,500,000 x 30% = 450,000 DTA

Fines are not deductible expenses for tax purposes.

PROBLEM 5

In connection with the audit of the company’s financial statements for the year ended December 31, 2006 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, 2003. Your audit showed the following details of the issue and the accounts as
of December 31, 2006:

Total face value P2,000,000

Date of bond March 1, 2002

Total proceeds P2,656,000

 Interest rate 12% per annum

Interest payment date March 1

Maturity dates and amount:

Date of maturity Amount

March 1, 2006 P 500,000

March 1, 2007 500,000

March 1, 2008 500,000

March 1, 2009 500,000

P2,000,000

Since the corporation had excess cash, bonds of P500,000 scheduled to be retired on March 1, 2008 were retired
on April 1, 2006. The total amount paid was charged to serial bonds payable account.

Serial Bonds Payable

3/01/2006 VR P500,000 4/01/2003 CR P2,656,000

4/01/2006 VR P495,000

Accrued Interest Payable

01/01/2006 GJ P200,000

Interest Expense

3/01/2006 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)

12. The adjusted balance of the bonds payable account as of December 31, 2006 is

a. P2,000,000 c. P1,500,000

b. P1,084,000 d. P1,000,000

13. The unamortized bond premium as of December 31, 2006 should be

 a. P66,642 c. P84,000

b. P82,444 d. P104,000

14. The accrued interest payable as of December 31, 2006 is

a. P150,000 c. P100,000

b. P120,000 d. P200,000

15. The bond interest expense that should be reported by the corporation for the year 2006 is

a. P55,264 c. P63,801

b. P58,000 d. P59,611

16. The gain on early retirement of bonds is

a. P79,000 c. P81,170

b. P77,722 d. P 0

D – C – C – B – A

Suggested Solution:

Question No. 1

Total bonds issued P2,000,000

Bonds retired, 3/1/06 (500,000)

Bonds retired, 4/1/06 (500,000)

Adjusted balance of bonds payable, 12/31/06 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 (2003 to 2005) P396,000

Current year (2006):

Bonds retired on maturity

(P500,000 x .006 x 2 mos.)
P6,000

Bonds retired prior to maturity

(P500,000 x .006 x 3 mos.)
9,000

Remaining bonds (P1,000,000

x .006 x 12 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, 12/31/06 P 84,000

Computation of amortization rate:

Bond Premium
outstanding amort.*
Year Period covered Mos. Peso months

2003 04/01-12/31 P2,000,000 9 P 18,000,000 P108,000

2004 01/01/-12/31 2,000,000 12 24,000,000 144,000

2005 01/01-12/31 2,000,000 12 24,000,000 144,000

2006 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

2007 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

2008 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

2009 01/01-02/28 500,000 2 1,000,000 6,000

P106,000,000 P636,000

Amortization rate = P636,000/P106,000,000 = .006

* Peso months x .006

Question No. 3

Accrued interest payable, 12/31/06

(P1,000,000 x 12% x 10/12)
P100,000

Question No. 4

Nominal interest:

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 for 2006 (see no. 2) 87,000

Interest expense in 2006 P 58,000

Question No. 5

Retirement price (P500,000 x .98) P490,000

Carrying amount of bonds retired:

Face value P500,000

Add unamortized bond premium,

(P500,000 x .006 x 23 mos.)
69,000 569,000

Gain on early retirement of bonds P 79,000

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

PROBLEM 6

An entity had a pretax accounting income of 3,000,000. During the year, it received 1,000,000 as proceeds from
life insurance of one of its officers who died during the year and recognized the related gain at 700,000 and a
corresponding decrease in the premiums expense amounting to 1/3 of the total 300,000 annual insurance premium.

Moreover, the company had the following bases at the end of the year:
Carrying amount Tax Base
PPE 5,000,000 4,000,000
Software Development Cost 500,000 0
Installment Receivable 2,000,000 0

Estimated Warranty Liability 300,000 0

The tax rate at the end of the year was 30%.

17. How much is the income tax expense?

A. 900,000 C. 750,000

B. 600,000 D. 540,000

18. How much is the current tax expense?

A. 300,000 C. 150,000

B. 360,000 D. 0

19. How much is the deferred tax liability

A. 300,000 C. 1,050,000

B. 450,000 D. 960,000

20. How much is the deferred tax asset?

A. 300,000 C. 960,000

B. 90,000 D. 690,000

D – D – C – A

Suggested solution:

17. Pretax Accounting Income 3,000,000

Life insurance proceeds gain (700,000)

Insurance expense 300,000

Decrease in insurance expense (100,000)

Accounting income subj. to tax 2,500,000

Tax rate 30%

Income tax expense 750,000

18. Accounting income subj to tax 2,500,000

PPE (1,000,000)

Software (500,000)

Installment receivable (2,000,000)

Estimated warranty liab 300,000

Taxable income (700,000)

Tax - 0
19. PPE 1,000,000

Software 500,000

Installment receivable 2,000,000

Future taxable amount 3,500,000

Tax rate 30%

DTL 1,050,000

20. Estimated Warranty liab 300,000

NOLCO 700,000

Future deductible amount 1,000,000

Tax rate 30%

DTA 300,000