Chapter 4

Provisions, Contingent Liabilities and

Contingent Assets

PROBLEM 1: TRUE OR FALSE

1. TRUE 6. FALSE
2. TRUE 7. TRUE
3. FALSE 8. FALSE
4. TRUE 9. FALSE
5. FALSE 10. TRUE

PROBLEM 2: FOR CLASSROOM DISCUSSION

1. B

2. B

3. B

4. D

5. C

6. Solutions:

Requirement (a):
(1,000,000 x 8%) = 80,000

Requirement (b):

Warranty obligation

20,000 64,000 2001: (800K x 8%)

70,000 80,000 2002: (1MK x 8%)
54,000

7. Solutions:
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Requirement (a):
(400,000 ÷ 5) x 60% x ₱.50 = 24,000

Requirement (b):
Liability for premium

(100K / 5) x ₱.50 10,000 24,000 Premium expense

14,000

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PROBLEM 3: EXERCISES

1. Solutions:

Requirement (a):
(3,200,000 ÷ 10) x 60% x ₱1.50 = 288,000

Requirement (b):
Liability for premium

(1.425M / 10) x 1.50 213,750 288,000 Premium expense

74,250

2. Solutions:

Requirement (a):
(640,000 ÷ 2) x 40% x ₱1.50 = 192,000

Requirement (b):
Liability for premium

(250K / 2) x 1.50 187,500 192,000 Premium expense

4,500

3. Solutions:

Requirement (a):
2004: 100,000 bags x 60% ÷ 3 coupons x ₱1.50 = 30,000

2005: 120,000 bags x 60% ÷ 3 coupons x ₱1.50 = 36,000

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Requirement (b):
Liability for premium
- 1/1/2004
Actual [(45K ÷ 3) x 1.50] 22,500 30,000 Premium expense

12/31/2004 7,500

Liability for premium

7,500 1/1/2005
Actual [(60K ÷ 3) x 1.50] 30,000 36,000 Premium expense

12/31/2005 13,500

4. Solutions:

Requirement (a):
2004:
Accounts Receivable 1,400,000
Sales 1,400,000

Warranty Expense 84,000

Estimated Liability Under Warranties 84,000

2005:
Estimated Liability Under Warranties 34,000
Inventory 10,000
Accrued Payroll 24,000

Requirement (b):
2004 ₱0.
2005 ₱34,000.

Requirement (c):
2004
Current Liabilities - Estimated Liability Under Warranties ₱42,000 (84K ÷ 2).
(The remainder of the ₱84,000 liability is a long-term liability.)

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5. Solutions:

Requirement (a):

Wrappers: 2004 2005

Redeemed during the current yr. 3,800,000 3,000,000
Expected to be redeemed the following yr. 2,600,000 3,600,000 (a)
Total 6,400,000 6,600,000
Divide by: No. of wrappers 10 10
Total 640,000 660,000
Multiply by: Net cost of premium 0.50(b) 0.50
Premium expense 320,000 330,000

(a)
(5,600,000 total wrappers redeemed – 2,600,000 from 2004) = 3,600,000
(b) (₱0.90 cost of mug + ₱0.60 mailing cost - ₱1.00 cash collection) = ₱0.50
net cost of premium

Requirement (b):
Liability for premium
- 1/1/2004
Actual [(3.8M ÷ 10) x .50] 190,000 320,000 Premium expense

12/31/2004 130,000

Liability for premium

130,000 1/1/2005
Actual [(5.6M ÷ 10) x .50] 280,000 330,000 Premium expense

12/31/2005 180,000

Requirement (c):

2004:
Inventory of Premium Mugs 864,000
Cash 864,000
(960,000 × .90 = 864,000)
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 Cash 3,750,000
Sales 3,750,000
(7,500,000 × .50 = 3,750,000)

Cash 152,000
Premium Expense 190,000
Inventory of Premium Mugs 342,000
[3,800,000 ÷ 10 = 380,000 × (1.00 – .60) = 152,000]
[380,000 × .90 = 342,000]

Premium Expense 130,000

Estimated Liability for Premiums 130,000
(2,600,000 ÷ 10 = 260,000 × .50 = 130,000)

2005:

Inventory of Premium Mugs 720,000

Cash 720,000
(800,000 × .90 = 720,000)

Cash 4,500,000
Sales 4,500,000
(9,000,000 × .50 = ₱4,500,000)

Cash 224,000
Estimated Liability for Premiums 130,000
Premium Expense 150,000
Inventory of Premium Mugs 504,000
[5,600,000 ÷ 10 = 560,000 × (₱1.00 – ₱.60) = ₱224,000
560,000 × ₱.90 = ₱504,000]

Premium Expense 180,000

Estimated Liability for Premiums 180,000
(3,600,000 ÷ 10 = 360,000 × ₱.50 = ₱180,000)

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PROBLEM 4: CLASSROOM ACTIVITY

Solution:

Sales in units 1,000,000

Multiply by wrappers estimated to be presented
for redemption 40%
Estimated wrappers to be presented for redemption 400,000
Divide by: Required number of wrappers for redemption 10
Estimated number of premiums to be distributed 40,000
Multiply by: Net cost of premium (P200 purchase
cost less P50 cash requirement from customer) P150
Premium expense P6,000,000

20x1 Premium expense 6,000,000

Estimated liability for 6,000,000
premiums
to record premium expense

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PROBLEM 5: MULTIPLE CHOICE – THEORY

1. D
2. D
3. C
4. D
5. B

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PROBLEM 6: MULTIPLE CHOICE – COMPUTATIONAL

1. C
Solution:
Liability for stamp redemptions
6,000,000 1/1/x6
Total redemption
Cost of redemptions (stamps cost of stamps
sold prior to 1/1/x6) 2,750,000 2,250,000 sold in 20x6
Cost estimate of stamps not
to be redeemed
(20% x 2,250,000) 450,000
12/31/x6 5,050,000

2. A ₱200,000 – the reasonable estimate as at year-end. The actual

settlement amount of ₱275,000 is disregarded because the
settlement occurred after the financial statements have been
issued.

3. D 500,000 – the estimated amount.

4. D
Solution:
Warranty liability
Actual warranty Warranty expense - 20x7
costs - 20x7 2,250 9,000 (150K x 6%)
Actual warranty Warranty expense - 20x8
costs - 20x8 7,500 15,000 (250K x 6%)
end. 14,250

5. B
Solution:
Liability for unredeemed coupon
Amt. disbursed 40,000 48,000 Issued on 7/1/x4 (120,000 x 40%)
end. 8,000

The coupons issued on 1/1/x4 and the related disbursements are

ignored because these items have already expired during the year.
Thus, they do not affect the year-end liability.