CHAPTER 45 LIABILITIES Premium, wary, a nty and deferred revenue QUESTION 45.1 Define liabilities, ANSWER 45-7 Liabilities are present oh):,.4: wansections of event nations of an entity arising from past result in an outfinn the Settlement of which is expected to Zammis Heebee ‘om the entity of resources embodying The essential characteristics of an accounting liability are: . The liability j ieati i a ability is the present obligation of a! particular entity. b. The liability arises from Past transaction or event. e The settlement of the liability requires an outflow of resources embodying economic benefits. QUESTION 45-2 Explain the measurement of current liabilities. ANSWER 45-2 - Conceptually, all: Kabilities ave initially measured at present value and subsequently measured at amortized cost. However, in practice, current liabilities or short-term ‘obligations are not discounted anymore but measured and reported at face amount. ‘ The reason is that the discount or the difference between the face amount and the present value is usually not material and therefore ignored. 591 Scanned with CamScannerQUESTION 46-3 he Explain the measurement of noncurrent liabilities. ANSWER 45-3 Noncurrent liabilities, for a noninterest-bearing note pay present value and subsequently eat If the long-term note payable is interest-bear ing; it is initially and subsequently measured at face arn al to the present value of the Je, are initially measureg xample, bond payable and measured at amortized cost In this case, the face amount is equi note payable. QUESTION 45-4 Explain an estimated premiwm liability. ANSWER 46-4 : Premiums are articles of value such as toys, dishes, silverware, and other goods and in some cases cash payments, given to customers as result of past sales or sales promotion activities, In order to stimulate the sale of their products, entities offe; premiums to customers in return for product labels, box tops, wrappers and coupons. QUESTION 45-5 What is a customer loyalty program?’ ANSWER 45-5 Many entities use a customer loyalty program to build brand _ loyalty, retain their valuable customers and of course, increase sales volume. 2 The customer loyalty program is generally designed to reward customers for past purchases and to provide them with incentives to make further purchases. If a customer buys goods or services, the entity grants the customer award credits often described as “points”. The entity can redeem the “points” by distributing to the customer free or discounted goods or services, 592 Scanned with CamScannerQUESTION 46. Explain an estimateg warranty liability ANSWER 45-6 Home appliances 1j refrigerators and the lik stereo sets, ratio sets, warranty to provi © are often sold under guarantee or ide free repai i vet 7 . © repair service or replacement during a Specified period jf the products are defective. ike television sets, oa ny tg dese scant cts on i part nak roducts sol ive i future within the specified eee defective in the Accordingly, at the point of * ne sale, a const i igati arises and a liability isi mstructive obligation neurred, QUESTION 45-7 Explain a deferred revenue. ANSWER 45-7 Deferred revenue or unearned revenue is income already received but not yet earned. Deferred revenue may be realizable within one year or in more than one year from the end of reporting period. If the deferred revenue is realizable within one year, it is classified as current liability. Typical examples of current deferred revenue are unearned interest income, unearned rental income and unearned subscription revenue. If the deferred revenue is realizable in more than one year, it is classified as noncurrent liability. Typical examples of noncurrent deferred revenue are unearned revenue from long-term service contracts and long-term leasehold advances. 593 Scanned with CamScannerQUESTION 45-8 Multiple choice (IAA) ‘1. Which is not considered a characteristic of a liability, Be Pp Present obligation Arises from past event Results in an outflow of resources ; Liquidation is reasonably expected to require yoy é existing resources classified as current assets 2. For a liability to exist op 29 . A past transaction or event must have occurred, . The exact amount must be known. The identity of the party owed must be known, An obligation to pay cash in the future must exigt, 8. Which of the following represents a liability? a. b. The obligation to pay for goods that an entity expects ’ to order from suppliers next year. The obligation to provide goods that customers have ordered and paid for during the current year. The obligation to pay interest on a five-year note payable that was issued at year-end. -d. The obligation to distribute an entity's own shares next year as a result of a share dividend. 4, Which does not.meet the definition of a liability? a. aes The signing of a three-year employment contract at a fixed annual salary . An obligation to provide goods or services in the future A note payable with no specified maturity date An obligation that is estimated in amount Scanned with CamScanner5. The conce liability is to a. Ptually appropriate method of measuring @ Dis a. the amount of expected cash outflows that market wana), '9 liquidate the liability using the aa of inte. haat . initially incurred! rest at the date the liability was are aan i amount, of expected cash outflows that mark oe to liquidate the liability using the ct rate of interest at the date of the financial statements, Record as liability the ammint of cash that would be ea to pay the liability in the ordinary course of Ronin on the date of the financial statements. oord as liability the amount of cash actually received when a liability was incurred. §. What is the relationship between present value and the concept of a liability? : Bese Present value is used to measure certain liabilities. Present value is not used to measure liabilities. Present value is used to measure all liabilities. - Present value is used to measure noncurrent liabilities only. : 7. Which is a characteristic of a current liability but not a noncurrent liability? a. b. Unavoidable obligation Present obligation that entails settlement by probable future transfer of cash, goods or services : Settlement is expected within the normal operating cycle or within 12 months, whichever is longer The obligating event creating the liability has already occurred 595 Scanned with CamScanner8. What is the relationship between current liabilities and an operating cycle? a, b. Cc d. Liquidation of current liabilities is reasonably expected within the operating cycle or one y whichever is longer Current liabilities are the result of Operating transactions Current liabilities cannot exceed the amount incurreg in one operating cycle There is no relationship between the two ear, 9. Which is not an acceptable presentation of current liabilities? da. a. Listing current liabilities in the order of maturity b. c Listing current liabilities according to amount Offsetting current liabilities against assets that are to be applied to their liquidation Showing current liabilities in the order of liquidation preference 10. Which statement is not true regarding the presentation of current liabilities in accordance with IFRS? a. The noncurrent liabilities follow the current liabilities, b. Current liabilities may be listed in the order of ‘maturity, in descending order of magnitude or in the order of liquidity preference. c. Current liabilities are generally recorded at face amount. d. Current liabilities should not be offset against the assets used for liquidation. i ANSWER 465-8 ld 6. a 20a qe 3. b 8. a 4. a 9. ¢ 5. a 10. a Scanned with CamScannerQUESTION 45-9 Multiple choice (AICPA Adapted) 1. Which 4 . Habilitioet following should be included in current b prede notes payable . Short-term fr . ; a Unearned we ee payable . of these are included in current liabilities 2. ror bg et measurement of liabilities at initial reflect and fresh start measurement should always The expectation he exy of the Historical cost ey ae sat Standing of the entity e most likely mini: i , ibe ain ely minimum or maximum possible Be oS 3. Ifa long-term debt becomes callable due to the violation of a loan covenant a. The debi may continue to be classified as long term if the entity believes the covenant can be renegotiated. The debt must be reclassified as current. Cash must be reserved to pay the debt. Retained earnings must be restricted equal to the amount of the debt. Bes 4, What is the classification of debt callable by the creditor? a. Noncurrent liability b. Current liability . ce. Current liability if the creditor intends to call the debt within one year : g. Current liability if it is probable that the creditor will call the debt within ore year ANSWER 45-9 appr d c b b 597 Scanned with CamScannerQUESTION 45-10 Multiple choice (IFRS) 1. pep op Itis a marketing scheme whereby an entity grants awang credits to customers and the entity can redeem the award credits in exchange for free or discounted goods, a. Customer loyalty program b. Premium plan c. Marketing program d. Loyalty award . The award credits granted to customers under a custome, loyalty program is,often described as a. Points b. Awards c. Credits d. Royalty . The consideration allocated to the points is measured at Stand-alone selling price of the points Carrying amount of goods to be received in exchange Fair value of the goods to be received in exchange The proportion of the stand-alone selling price of the points relative to the total of the stand-alone selling price of the points and the stand-alone selling price of the goods. . Under a customer loyalty program, the consideration allocated to the points a. Shall be recognized as revenue immediately. b. Shall not be accounted for as revenue separately. c. Shall be recognized initially as deferred revenue and ‘amortized as revenue over a reasonable period. d. Shall be recognized initially as deferred revenue and subsequently “ecognized as revenue upon the redemption of the points. ; ANSWER 45-10 loa 3. d 20a: 4d 588 Scanned with CamScannerQUESTION 45-11 Multiple choice (IAA) 1.The accrual a - i i ‘oduct warranty cost PProach in accounting for pr a. Is required for im b. Is frequently justi warranty cost j c. Finds the ex come tax purposes. ified on the basis of expediency when t is immaterial. ‘ Pense account being charged when the seller performs in compliance with the warranty. d. Represents accepted practice and should be used whenever the warranty is an j " inseparable part of the gale y is an integral and insep 2. Which best descr : ibes the accrual approach of accounting for wary, ‘anty cost? a. Expensed when paid b. Expensed when warranty claims are certain c. Expensed based on estimate in year of sale d. Expensed when incurred 3. Which best describes the expense approach of accounting for warranty cost? Expensed based on estimate in year of sale Expensed when liability is accrued Expensed when warranty claims are certain Expensed when incurred Boop 4, When an entity has a continuing policy of guaranteeing new products against defects for three years, the liability arising from the warranty a. Should be reported as noncurrent. b. Should be reported as current. c. Should be reported as part current and part noncurrent. d. Need not be disclosed. ANSWER 465-11 ld 3. d Ze: 4. ¢ Scanned with CamScannerMs QUESTION 45-12 Multiple choice (AICPA Adapteg) ‘1. A retail store received cash.and issued gift certificg that are redeemable in merchandise. How would 4 deferred revenue account be affected by the redemptj,, and nonredemption of certificates, respectively? .a,, Decrease and No effect b. Decrease and Decrease c. No effect and No effect d. No effect and Decrease ‘2. A retail store received cash and issued a gift certificate that is redeemable in merchandise. When the gig certificate was issued Deferred revenue account should be decreased Deferred revenue account should be increased Revenue aécount should be decreased Revenue account should be increased (perp - 8, Magazine subscriptions collected in advance are treated as Acontra account to magazine subscriptions receivable “Deferred. revenue in the liability section Deferred revenue in the shareholders’ equity. section . Magazine subscription refund in the income statement in the period collected Bo sp 4. When an entity received an advance payment for special order goods that are to be manufactured and delivered within six months, the advance payment is reported as a. Deferred charge b. Contra asset account _¢. Current liability d. Noncurrent liability Scanned with CamScanner“a. Deferred ' Under a royalty a, . In dune of the c . An entity is g ; i etailer of home appli d offers a servic appliances and offe appliance ©n each appliance sold. ‘The entity sells contracts ie ¢Stallment contracts but all service Collections St be paid in full at the time of sale. Teccived for sarvion - be recorded as an increaeg ri service contracts shall revenue account i niracts receivable vajuation account ers’ equity valuation account revenue account . Sales con c. Shareho Service ‘Sreement with another-entity, an entity will receive royalties fi i rom the assignment of a patent for four years, The Toyalties received in advance shall be reported as revenue . In the period received In the period earned Evenly over the life of the royalty agreement At the date of the royalty agreement Be op ‘urrent year, an entity sold refundable merchandise coupons. ‘The entity received a certain amount for each coupon redeemable from July i to December 31 of the current vear, for merchandise with a certain retail price. At June 30 of the current year, how should the entity report these coupon transactions? a. Unearned revenue at the merchandise retail price b. Unearned revenue at the cash received c. Revenue at the merchandise’s retail price d. Revenue at the cash received . How would the proceeds received from the advance-sale of nonrefundable tickets for a theatrical performance be reported hefore the performance? a. Revenue for the entire proceeds b. Revenue to the extent of related costs expended c. Unearned revenue to the extent of related costs expended .d. Unearned revenue for the entire proceeds 601 Scanned with CamScanner9. At the end of the current year, 40 entity received an advance payment of 60% of the sales price for special order goods to be manufactured and delivered within five months. At the same time, the entity subcontracted for production of the special order goods at a price equal to 40% of the main contract price. What liabilities should be reported in the entity's year-end statement of financia} position? ° a. None b. Deferred revenue equal to 60% price and payable to. subcontrac the main contract price : c. Deferred revenue equal to 60% of the main contract price and no payable to subcontractor d. No deferred revenue but payable to subcontractor is reported at 40% of the main contract price of the main contract tor equal to 40% of 10. An entity sells appliances that include a three-year warranty. Service calls under the warranty are performed by an independent mechanic under a contract with the entity. Based on experience, warranty-costs are expected to be incurred for each machine sold. When should the entity recognize these warranty costs? Evenly over the life of the warranty When the service calls are performed When payments are made to the mechanic When the machines are sold ae re ANSWER 45-12 yeeter porars OM OnnD aenae eo 602 Scanned with CamScannernee CHAPTER 46 (PROVISION. QUESTION 46-1 What do you understand by the term “provision”? SWER 46- ANSE AO fat gab) pravsion is an existing liability of uncertain timing or uncertain The essence of a provision is that there is fy about the timing or amount of the future expenditure") af! _ Actually, a provision may be the equivalent of an estimated | Hiability or a loss contingency that is accrued because it 18 both probable and measurable. ~~ QUESTION 46-2 What are the conditions for the recognition of a provision as liability? ANSWER 46-2 PAS 37, paragraph 14, states that a provision shall be recognized. as liability under the following condi 7 603 Scanned with CamScannerQUESTION 46-3 What is a present obligation? ANSWER 46-3 The present obligation may be legal or constructive. It is fairly clear what a legal obligation is. A legal obligation is an obligation arising from a contrac, legislation or other operation of law. . A consiructive obligation is an obligation that is derived from an entity’s actions where: a. The entity has indicated td other parties that it will cecept certain responsibilities by.reason of an established pattern of past practice, published policy, or a sufficiently specific current statement. bag ‘Andas‘a résult the entity has dreated a valid expectation on the part of other parties that it will discharge those reaponsibilities. ak a ‘. QUESTION 46-4 What is an “obligating event”? ANSWER 46-4 — The past event that leads to a present obligation is called an obligaling event. 7 or tic rere This is the case where: ~..... a The settlement of the obligation can be énforced by law. The event creates valid expectation on the part of other -~parties that the entity will diecharge the obligation, as In the case of constructive obligation. i Scanned with CamScannerQUESTION 46-6 Explain briefly “probable outflow of economic benefits”. ANSWER 46-5 For a provision to qualify for recognition, there must be not only a present obligation but also a probable outflow 0! resources embodying economic benefits to settle the obligation. ; An outflow of resources is re; “ ” if th t i * garded as “probable” if the even is more likely than | not to occur. This means that the probability that the event will occur is greater than the probability that the event will not occur. b; “probable” means more, than 50% likely. QUESTION 46-6 Explain the measurement of a provision. ANSWER 46-6 ; The amount recognized asa provision should be the best estimate of the expenditure required to settle the present obligation at the end of reporting period. re The best estimate is the amount that an entity would rationally pay to settle the obligation, at the reporting date or to transfer it to a third party at that time. Where a'single obligation is being measured, the individual most likely outcome may be the best estimate. However, even in such a case, the entity shall consider other possible outcomes. i Where there is a continuous range of possible outcomes and each point in that range ts os likely as any other, the midpoint of the range is used. » 4 7 _ Where the provision being measured involves a large population of i the obligation is estimated by “weighting” all possible outcdmes by their associated possibilities. 605 Scanned with CamScannerQUESTION 46-7 Enumerate certain considerations in the measurement of provision. ANSWER 46-7 a. The risks and uncertainties that inevitably surround man events and circumstances shall be taken into account in reaching the best estimate of a provision. Where the effect of the time value of money.is material, the amount of provision shall be the present value of the expenditures required to settle the obligation. Future events that affect the amount required to settle an obligation shall be reflected in the amount of a provision, Gains from expected disposal of assets Chall not be taken into account in measuring a provision. Where the expenditure required to settle a provision ig expected to be reimbursed. by..another , the reimbursement shall be recognized when it tually certain that reimbursement will be received. —— coe The reimbursement shall be treated as a senarate asset and .not “netted” against the estimated liability for the provision, The amount sh: eed the amount of the provision. unt shall not.excee Pi } However, in the income statement, the expense relating to the provision may be presented net of the reimbursement, Provisions shall be reviewed. reporting date and adjusted to reflect the current best estimate. = A provision shall be used, only_for-expenditures for which the provision was originally recognized. 3 Provision'shall notibe recognized for future operating losses. 25. (onto a Tf an entity has an onerc tract, the present obligation under the onerous\gontract shall be recognized and measured as a provision) ~ 606 Scanned with CamScannerQUESTION 46.3 What is restructuring? ANSWER. 46-8 Bi Oar bareeraph 10, defines restructuring as a “program that changes either the seme a by management and materially A i F ofa A ner in which that business is condneae ot an entity or the manne! Examples of events that may qualify as restructuring include: a. Sale or termination of a line of business. a f Db. (losiire of business location in a region or relocation of ess activities from one location to another. c. Change in management structure, such as elimination of a layer of management. | a. Fundamental reorganization of an entity that has a material and significant impact on the operations. QUESTION 46-9 What is the amount of the restructuring provision? ANSWER 46-9 | A restructuring provision shall include only direct expenditures arising from the restructuring. | The expenditures are necessarily entailed by the restructuring and not associated with the ongoing activities of the entity. ' For example, salaries and benefits of employees to be incurred after operations cease and that are associated with the closure of the operations shall be included in the amount of the restructuring provision. PAS 37, paragraph 81, specifically excludes the following expenditures from the restructuring provision: a. Cost of retraining or relocating continuing staff. b. Marketing or advertising program to promote the new entity image. c. Investment in new system and distribution network. 607 Scanned with CamScanner© an ou! QUESTION 46-10 Multiple choice (PAS 87) 1, Which is the correct definition of a provision? a, b. © d. a a9 . A possible obligation arising from past event” A liability of uncertain timing or amount . A liability which cannot be easily measured An obligation to transfer funds to an entity . A provision shall be recognized as liability when An entity has a present obligation as a result of a past event. It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation. ’ The amount of the obligation can be measured reliably, All of these are required for the recognition of a provision as liability. . A legal obligation is an obligation that is derived from all. of the following, except a. b. c. d. E ae oP Legislation A contract : Other operation of law An established pattern of past practice . A constructive obligation is an obligation That is derived from an entity's action that the entity will accept certain responsibilities because of past practice, published policy or current statement. . The entity has created a valid expectation in other parties that it will discharge those responsibilities. I only TI only ‘ Both I and II . Either I or II . Scanned with CamScanner5. 6. 1: 8. It is an ev i because the me reates a legal or constructive obligation settle the obligation no other realistic alternative but to Obligating event Past event Subsequent’ event . Current event pe oe An outflow of resource, inj i s em i regarded as “probable” vee ee a. = 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 probability that the event will occur. ce. 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 90% likely. Where there is a continuous range of possible outcomes, and each. point in that range is as likely as any other, the range to be used is the ; Minimum i Maximum ; Midpoint Sum of the minimum and maximum pep When the provision involves a large population of items, the estimate of the amount a. Reflects the weighting of all possible outcomes by their associated probabilities. b. Is determined as the individual most likely outcome. c. May be the individual most likely outcome adjusted for the effect of other possible outcomes. d. Midpoint of the possible outcomes. Scanned with CamScannernat 9. When the provision arises from a single obligation, the estimate of the amount a. Reflects the weighting of all possible outcomes by the, associated probabilities. r b. Is determined as the individual most likely outcome c. Is the individual most likely outcome adjusted for the ; effect of other possible outcomes. d. Midpoint of the possible outcomes. 10. Which statement is incorrect where the expenditure required to settle a provision is expected to be reimburseq by another party? a. The reimbursement shall be recognized only when ‘it ig virtually certain that the reimbursement would be received if the entity settles the obligation. b. The amount of the reimbursement shall not exceed the amount of the provision. c. In the income statement, the expense relating to the provision may be presented net of the reimbursement, d. The reimbursement shall not be treated as separate asset but “netted” against the estimated liability for the provision. ANSWER 46-10 1. b 6. a 2.d qe 3. d 8 a 4,.c¢c - % e 5.0 a 10. d 610 Scanned with CamScannerQUESTION 46-11 Multiple choice (PAS 37) 1, Which statement is not true in relation to the measurement of a provision? a. The risks and uncertainties that inevitably surround many events and circumstances shall be taken into account in reaching the best estimate of a provision. Where the effect of the time value of money is material, the amount of a provision shall be the Present value of the expenditure expected to settle the obligation. Future events that may affect the amount required to settle the obligation shall be reflected in the amount of the provision where there is sufficient objective evidence that the future events will occur. Gains from expected disposal of assets shall be taken into account in measuring a provision. 2. Provisions shall be discounted if the effect of the time value of money is material. Which of the following is incorrect regarding the discount rate? Reflects current market: assessment of the time value of money Reflects risks specific to the liability Does not reflect risks for which future cash flow estimates have been adjusted Is a post-tax discount rate 3. Which statement is incorrect concerning recognition of a provision? a. b. Provisions shall be reviewed at the end of each reporting period and adjusted to reflect the current best estimate. A provision shall be used only for expenditures for which the provision was originally recognized. Provisions shall be recognized for future operating losses. If an entity has an onerous contract, the present obligation under the contract shall be recognized and measured as a provision. 611 Scanned with CamScanner4. It is a contract in which the unavoidable costs of Meeting the obligation under the contract exceed the economic benefits to be received under the contract. a, Onerous contract b. Executory contract c. Executed contract d. Sale contract 5. The unavoidable costs under an onerous contract represent the “least net cost of exiting from the contract” . which is equal to a. Cost of fulfilling the contract b. Penalty arising from: failure to fulfill the contract c. Lower of the cost of fulfilling the contract or the penalty arising from failure to fulfill the contract d. Higher of the cost of fulfilling the contract or the penalty arising from failure to fulfill the contract ANSWER 46-11 Lu ao pF © be o 7p Oo & 612 Scanned with CamScannerUEST! Q TON 46-12 Multiple choice (PAS 87) . 1. This i and. coe eied ae a structured’ program that is planned changes ei ed by the management that materially ieannorin the Scope of a business of an entity or the which that business is conducted. Restructurin Liquidation . Recapitalization Corporate revamp Be oP 2. Examples of events th . aa : : that é nelude all of the following, eae as restructuring i a. Sale or termination of business ; -b. Closure of business location in a region or relocatio: of business from one location to another hange in management structure such as elimination of a layer of management d. Fundamental reorganization of an entity that has an immaterial and insignificant impact on the operations. c. 3. Which is a cost of restructuring? . Cost of retraining or relocating continuing staff Marketing or advertising cost Investment in new system and distribution network Cost of relocating business activities from one location to another ‘ROP 4, It is the abusive practice of manipulation and creative accounting by dumping all kinds of provisions under the banner of provision for restructuring. a. Big bath provision b. Creative accounting c. Cookie jar d. General reserve ANSWER 46-12 lai. 3.4 2. d 4.8 613 Scanned with CamScannerQUESTION 46-18 Multiple choice (IFRS) 1. For whic! Bore fh of the following should a provision be recognized? Future operating losses Obligations under insurance contracts Reductions in fair value of financial instruments Obligations for plant decommissioning costs 2. Provisions shall be recognized for all of the following, except a. Cleaning-up costs of contaminated land when an oil. entity has a published policy that it will undertake to clean up all contamination that it causes. Restructuring costs after a binding sale agreement has been signed. ; Rectification costs relating to defective products already sold. ‘ Future refurbishment costs due to introduction of anew computer system. 3. An entity is closing one of its operating divisions, and the conditions for making restructuring provision have been _ met. The closure will happen in the first quarter of the next financial year. At the current year-end, the entity has announced the formal plan publicly and is calculating the restructuring provision. Which of the following costs should be included in the restructuring provision? a. b. Cc. Retraining staff continuing to be employed. Relocation costs relating to staff moving to other divisions Contractually required costs of retiring staff being made redundant from the division being closed Future operating losses of the division being closed up to the date of closure 614 Scanned with CamScanner4. An enti F j include ene _ chemical plants. Its published policies to the énvirctin ‘tment to making good any damage cause this commitme i by the operations. It has always honored give rise to nt. Which of the following scenarios would an environmental provision? “ Gane eae itis likely that a chemical spill which va Tesult in having to pay fines and penalties will occur in the next year. b, ek research suggests there is a possibility that the Th § actions may damage surrounding wildlife. c. tne government has outlined plans for a new law Fequiring all environmental damage to be rectified. d, ‘Achemical spill from one of the entity's plants has caused harm to the surrounding avea and wildlife. . An entity has been served a legal notice at year-end by the Department of Environment and Natural Resources to fit - smoke detectors in its factory on or before middle of next year. The cost of fitting smoke detector can be measured reliably. How should the entity treat this at year-end? a. Recognize a provision for the current year equal to the estimated amount. b. Recognize a provision for the current year equal to one-half only of the estimated amount. c. No provision is recognized at year-end because there is no present obligation for the future expenditure since the entity can avoid the future expenditure by changing the raethod of operations but disclosure is required. d. Ignore this for purposes of the financial statements at year-end. ANSWER 46-13 ld 26d 3. ¢ 4.da 5. c 615 Scanned with CamScannerQUESTION 46-14 Multiple choice (AICPA Adapted) 1. A provision is a. pes An event which is not recognized because it is not probable or cannot be measured reliably. : An event which is probable and measurable. An event which is possible and measurable. An event which is probable but not measurable, 2. Which of the following would not considered a “provision”? a. b, c. 4, Warranty liability Bad debt ‘Tax payable Note payable 8. In calculating present value ip a situation with a Tange of possible outcomes all discounted using the same interest - rate, the expected present value would be a. b. c. d. The most-likely outcome The maximum outcome The minimum outcome ; The sum of probability-weighted present values 4. An entity received notification of legal action against the entity. The attorneys determined that it is probable the entity will lose the suit and the loss can be estimated reliably. How should the estimated loss be reported? a. b. sc, da. As a loss recorded in other comprehensive income As a loss in the income statement and a contingent liability in the statement of financial position As a loss in the income statement and a provision in the statement of financial position In the notes to financial ‘statements as a contingency ANSWER 46-14 Lb 2d 3. d 4. ¢ 616 Scanned with CamScannerCHAPTER 47 CONTINGENT LIABILITY AND CONTINGENT ASSET QUESTION 474 What is a Contingent liability? ANSWER 47.1 Py oe a are Paragraph 10, defines a contingent liability in two a. Acontingent liability is a possible obligation that arises from Past event and whose existence will be confirmed only by the occur: fu tu rence or nonoccurrence of one or more uncertain re events not wholly within the entity's control: A contingent liability is a present.obligation that arises from Past event but is not recognized because it is not probable that a transfer of economic benefits will be required to settle the obligation or the amount of the obligation cannot be measured reliably. oe QUESTION 47-2 Explain the three ranges of outcome of future uncertain events. : ANSWER 47-2 The uncertainty relating to future events can be expressed by a range of outcome. The range of outcome may be described as follows: a. ‘obable ; ~ The future event is likely to occur. As arule of thumb, probable means more than 50% likely.. ——— See _ carne renters b. ‘Reasonably sibie — The future event is less likely to occur. c. ‘Remotel- The future event is least likely to occur or the @hatice of the future event occurring is very slight. 617 Scanned with CamScannerQUESTION 47-3 What is the treatment of a contingent liability? ANSWER 47-3 : . statements but shall be disclosed only. — If the contingent liability is remote, no @ disclosure is eveernlys QUESTION 47-4: What is a contingent asset? ANSWER 47-4 PAS 37, paragraph 10, defines a contingent asset asa possible asset, that arises from past everit’and whose existence will be confirmed by the occurrence ‘or nonoccurrence of one or more uncertain future events not wholly within the entity’s control. A contingent asset shall not be recognized because this may result to recognition of income that may never be realized. However, when the realization of income is virtually certain, the related asset is no longer contingent asset and its recognition is appropriate. i A contingent asset is only disclosed when itis probable. If a contingent asset is only possible or remote, no disclosure is required. 618 Scanned with CamScannerQUESTION 47-5 Multiple choice (PAS 87) 1. A contingent liability is a. An estimated liabili b. An event whit: we probable thehich is not recognized because it is not AN outflow will b ired or the amount cannot be reliab} , e required or the c. A potential large apie d. A potential small liability 2, The likelihood that th can be expressed b means that the fu i Etobable : asonabh: i c. Certain ee d. Remote e future event will or will not occur Y @ range of outcome. Which range ure event occurring is very slight? 3. Which. statement i, liability? * a. A contingent liability j 7 i i ancial Ststemenee y is not recognized in the fin: b. A contingent liability is disclosed only. : c. If the contingent liability is remote, no disclosure is required, : d. A contingent liability is both probable and measurable. incorrect concerning a contingent 4. hich statement is incorrect concerning a contingent asset? ss a. A contingent asset is not recognized in the financial statements because this may result to recognition of income that may never be realized. b. When the realization of income is virtually certain, the related asset is no longer contingent asset and its recognition is appropriate. c. Acontingent asset is only disclosed when the occurrence of the future event is possible or remote. d. The related gain arising from the contingent asset is recognized usually when it is realized. ANSWER 47-5 lb 3. d 26d 4. ¢ 619 Scanned with CamScannerQUESTION 47-6 Multiple choice (AICPA Adapted) 1, An entity did not record an accrual for a Present obligation but disclose the nature of the obligation and the range of the loss, How likely is the toss? a. peta asonabh: ibl c. Probable ee Certain 2. A present obligation that is probable and for which the amount can be reliably measured should a. Not be accrued but disclosed in the notes to the financial statements. ; ; b. Be accrued by debiting an appropriated retained earnings account and crediting a liability account, — c. Be accrued by debiting an expense account and crediting an appropriated retained earnings account yi d. Be accrued by debiting an expense account and crediting a liability account. 3. An entity has a self-insurance plan. Each year, the entity appropriated retained earnings for contingencies in an amount equal to insurance premiums saved less recognized ~ losses from lawsuits and other claims. As a result of an accident in the current year, the entity is a defendant in a lawsuit in which it would probably have to pay measurable amount of damages. What are the effects of the lawsuit’s probable outcome on the entity’s financial statements for the current year? a. An increase in expenses and no effect on liabilities b. An increase in both expenses and liabilities c. No effect on expenses and an increase in liabilities d. No effect on either expenses or liabilities 4. An expropriation of asset which is imminent and for which the amount of loss can be reasonably estimated should be Accrued Disclosed ‘Accrued and disclosed. Ignored a9 of Scanned with CamScanner5. An enti ntity operates a plant in a foreign country. It is Probab! ‘ he raietecae the plant will be expropriated. However, reveive 2 deeecrnment has indicated that the entity will pvamgunt ae amount of compensation for the plant. but exceeda Phe eeeteation is less than the fair value ; arrying amount of th contingent asset should be reported eae a cc elses allowance as a part of shareholders’ . raged asset valuation allowance account “ = € notes to financial statements - In the statement of financial position 6. Reserves for conti i i risks should ontingencies for general or unspecified - Be accrued in the financial statements and disclosed, . Not be accrued in the financial statements and need not be disclosed. c. Not be accrued in the financial statements but should e disclosed. d. Be accrued in the financial statements but need not be disclosed. 7. Contingent assets are usually recognized when a. Realized b. Occurrence is reasonably possible and the amount can be reliably measured ce. Occurrence is probable and the amount can be reliably measured d. The amount can be reliably measured 8. Which of the following is the proper accounting treatment of a contingent asset? a. An accrued account b. Deferred earnings c. - An account receivable with an additional disclosure explaining the nature of the transaction d. A disclosure only Scanned with CamScanner9. When the occurrence of 10. At year-end, an entity was suins . infringement. The awar gent asset is probable a contin 0 the contingent and the amount can be reliably measured, asset should be a. Recognized in the statement disclosed. . ined . b. Classified as an appropriation of retained earnings, c. Disclosed but not recognized’ 1n the statement of financial position. ffi 3 d. Neither recognized in the statement of Hnancial position nor disclosed. of financial position ang ga competitor for patent d from the probable favorable outcome can be reliably measured. The entity’s financial « pected award aa statements should report the ex Receivable and revenue Receivable and reduction of patent — Receivable and deferred revenue Disclosure only Bore ANSWER 47-6 Pee Ee eoras SLHaAID RBenarpo Scanned with CamScannerQUESTION 47-7 Multiple choice (IAA) a, Contingent liabiliti i i liabilities depen will or will not become actual a. Whether probable and measurable. e degree of uncertainty. a The present condition suggesting a liability. - The outcome of a future event. . A contingent liability shall be recognized when a. Any lawsuit is actually filed against an entity. b. It is certain that funds are available to pay the amount of the claim. c. It is probable that a liability has been incurred even though the amount of the !oss cannot, be reliably measured. d. The amount of the loss can be reliably measured and it is probable prior to issuance of financial statements that a liability has been incurred. - How should a contingent liability be reported in the financial statements when it is reasonably possible that the entity will have to pay the liability at a future date? . a. As a deferred liability b. As an accrued liability c. As a disclosure only d. As an account payable with an additional disclosure explaining the nature of the transaction _ . Disclosure usually is not required for a. Contingent gains that are probable and can be reliably measured. b. Contingent losses that are reasonably possible and cannot be reliably measured. c. Contingent losses that are probable and cannot be _ reliably measured. d. Contingent losses that are remote and can be reliably measured. Scanned with CamScanner. Reporting in the financial statements is required for a. Loss contingencies that are probable end can be reliably measured. b. Gain contingencies that are probable and can be reliably measured. : . ¢. Loss contingencies that are possible and can be teliably measured. : d. All loss contingencies. . Gain contingencies that are remote and can be reliably measured y Must be disclosed in a note to the financial statements, May be disclosed in a note’ to the financial statements, Must be reported in the body of the financial statements, Should not be reported or disclosed. Boop tA contingent liability’ a. Has a most probable value of zero but may require -... Payment if a given future event occurs. : b. Definitely exists as a liability but the amount or due date is indeterminate. ; ¢. Is commonly associated with loss carryforward. d.. Is-not disclosed in the financial. statements. . Which of the following should be disclosed in the financial statements as a contingent liability? a. The entity has accepted liability prior. to the year-end. for unfair dismissal of an employee and is to pay damages. b. The entity has received a letter from a supplier complaining about an old unpaid invoice. c. The entity is involved in a legal case which it may possibly lose. d. The entity has not yet paid certain claims under product warranty. Scanned with CamScanner9. What conaje: i dition ; 7 €avironmenta] liability necessary to recognize an a T i pai thed mE, has. 4n existing legal obligation and the b. The en ia the liability can be reliably estimated. liability, Y can reliably estimate the amount of the = The entity has an existing legal obligation. d. Obligating event has occurred. 10. Which of the following is not considered when evaluating whether or not to record a liability for pending litigation? a. Time period in which the underlying cause of action occurred b. The type of litigation involved c. The probability of an unfavorable: outcome d. The ability to make a reliable estimate of the loss ANSWER 47-7 ad 6. d d Tea c 8 ¢ . a % a a. .10 b oe Oe Scanned with CamScanner