No. 125 Brgy.

San Sebastian
Lipa City, Batangas, Philippines
Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : icarecpareview@gmail.com

AP03-03 jsabellar/aljabinal/aeibay
AUDIT OF LIABILITIES

PROBLEM I.

The ARISTOTLE CORP. has been producing quality shoes and apparels for men for more than
three decades The company’s fiscal year runs from April 1 to March 31. The following refers to
the obligations of ARISTOTLE as of March 31, 2020.
BONDS PAYABLE
ARISTOTLE issued P10,000,000 of 10% bonds on July 1, 2018. The prevailing market
rate of interest for these bonds was 12% on the date of issue. The bonds will mature on July 1,
2028.
Interest is paid semiannually on July 1 and January 1. ARISTOTLE uses the effective
interest rate method to amortize bond premium or discount.
NOTES PAYABLE
ARISTOTLE has signed several long-term notes with banks. The maturities of these notes
are given in the schedule below. The total unpaid interest for all of these notes amounts to
P600,000 on March 31, 2020:
Due DATE Amount Due
April 1, 2020 P 400,000
July 1, 2020 600,000
October 1, 2020 300,000
January 1, 2021 300,000
April 1, 2021 March 31, 2022 1,200,000
April 1, 2022 March 31, 2023 1,000,000
April 1, 2023 March 31, 2024 1,400,000
April 1, 2024 March 31, 2025 800,000
April 1, 2025 March 31, 2026 1,000,000
P 7,000,000

ESTIMATED WARRANTIES
ARISTOTLE has a one-year product warranty on some selected items in its product line. The
ESTIMATED WARRANTY LIABILITY on sales made during the 2018-2019 fiscal year and still
outstanding as of March 31, 2019 amounted to P180,000. The warranty costs on sales made April
1, 2019 through March 31, 2020 are estimated at P520,000. The actual warranty costs incurred
during the current 2019-2020 fiscal year are as follows:

Warranty claims honored on 2018-2019 P180,000

Warranty claims honored on 2019-2020 178,000
Total warranty claims honored P 358,000
OTHER INFORMATION REGARDING OTHER LIABILITIES:
A. PAYROLL RELATED ITEMS:
Accrued salaries and wages P300,000
Withholding taxes payable 94,000
Other payroll deductions (SSS, Phil. Health) 10,000

B. TRADE ACCOUNTS PAYABLE

Accounts payable for supplies, goods, and services purchases on the open account amounted to
P740,000 as of March 31, 2020.

C. MISCELLANEOUS ACCRUALS.
Other accruals not separately classified amount to P150,000 as of March 31, 2020.

D. DIVIDENDS
On March 15, 2020, ARISTOTLE’s BOARD OF DIRECTORS declared a cash dividend of
P0.20 per common share and a 10% ordinary stock dividend. Both dividends were to be
distributed on April 15, 2020, to the ordinary shareholders of record at the close of business on
March 31, 2020. Data regarding ARISTOTLE ordinary shares are as follows:

Par Value P5.00 per share

Number of shares issued and outstanding 6,000,000 shares

Market values of ordinary shares:

March 15, 2020 P22.00 per share
March 31, 2020 P21.50 per share
April 15, 2020 P22.50 per share

REQUIREMENTS
1. How much was received by ARISTOTLE from the bonds issued on July 1, 2018?
A. P10,000,000 B. P10,500,000 C. P10,647,040 D. P8,852,960
2. On March 31, 2020, ARISTOTLE’s statement of financial position would report total
current liabilities of:
A. P4,386,000 B. P5,336,000C. P5,642,000 D. P5,286,000
3. On March 31, 2020, ARISTOTLE’s statement of financial position would report total
noncurrent liabilities of
A. P14,389,350 B. P14,352,217 C. 14,252,960 D. P14,370,783

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PROBLEM II.

On January 1, 2020, COPPERNICUS CORP. issued 2,000 of its 5-year, P1,000 face
value, 11% bonds dated January 1 at an effective annual interest rate (yield) of 9%. Interest is
payable each December 31. COPPERNICUS uses the effective interest method of amortization.
On December 31, 2021, the 2,000 bonds were extinguished early through acquisition in the open
market by COPPERNICUS for P1,980,000 plus accrued interest.

On July 1, 2020, COPPERNICUS issued 5,000 of its 6-year, P1,000 face value, 10%
convertible bonds at par.Interest is payable every June 30 and December 31. On the date of issue,
the prevailing market interest rate for similar debt without the conversion option is 12%. On July
1, 2021 an investor in COPPERNICUS’ convertible bonds tendered 1,500 bonds for conversion
into 15,000 shares of COPPERCINUS ordinary shares, which had a fair value of P1i05 and a par
value of P1.00 at the date of conversion.

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

1. Issue price of the 2,000 5-year, P1,000 face value bonds on January 1, 2020 is
A. P2,000,000 B. 1,844,400 C. P2,155,500 D. P2,147,800

2. The carrying value of the 2,000 5-year, P1,000 face value bonds on Dec. 31, 2020 is
A. P1,898,400 B. P2,000,000 C. P2,129,500 D. P2,121,100

3. The gain on early retirement of bonds on December 31, 2021

A. P20,000 B. P112,000 C. P121,200 D. P50,000

4. The carrying value of the 5,000 6-year, P1,000 face value bonds on Dec. 31, 2020 is
A. P4,605,800 B. P5,000,000 C. P4,732,875 D. P4,615,400

5. The conversion of the 1,500 6-year P1,000 face value bonds on July 1, 2021 will increase
the share premium by
A. P1,374,600 B. P1,485,000 C. P1,415,054 D. P1,377,697

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PROBLEM III. CONTINGENT LIABILITIES AND PROVISIONS

1. GEOGRAPHY COMPANY, on March 1, 2022, issued its 2021 financial statements. The
following data were presented by the company and its accounting staff for the year then ended
December 31, 2021. You were assigned to audit the contingent liabilities and provisions that may
require notes and disclosures.

1. Estimated cost of overhauling the factory equipment every 5 years (the 1.600,000
equipment is 5 year-old on December 31, 2021)
2. Estimated cost of relocating an employee from Mandaluyong Head 400,000
Office to a branch in the Bicol region (the employee shall physically
relocate in January 2022)
3. Estimated long service leave owing to employees in respect to past 1,800,000
services
4. Amount owing to another company for services rendered during Dec. 500,000
2021

Based on your audit findings and appreciation of the data, what amount should be recognized as
PROVISION on December 31, 2021.
A. 4,300,000 B. 3,800,000 C. 2,500,000 D. 1,800,000

2. In May 2021, ALBAY COMPANY relocated an employee from the Makati head office to a
satellite branch in Sorsogon Bicol Region. At the end of reporting period on June 30, 2021, the
costs are estimated at P385,000 analyzed,, compiled, and audited as follows:

1. Cost for shipping personal effects and goods 60,000

2. Airfare from Domesic Airport to Legaspi City and land transportation to 20,000
Sorsogon
3. Temporary accommodation costs for May and June 80,000
4. Temporary accommodation costs for July and August (lease was terminated 85,000
in May)
5. Reimbursement for cost of living increases for the period May 1, 2021 to 120,000
May 1, 2022
6. Reimbursement for lease break cost paid in July (lease was terminated in 20,0i00
May)
Total 385,000

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Per your audit of the liability accounts, what amount should be recognized as provision for
relocation costs on June 30, 2021?
A. 385,000 B. 345,000 C. 200,000 D. 300,000

3. The CAMANAVA MINING COMPANY has long been operating a mining site that has been
discovered to be environmentally risky and the site is likewise discovered to be contaminated by
toxic waste. The company has acknowledged its responsibility for the contamination.
An initial clean up feasibility study has shown that it will cost at least P15,000,000 to clean
up the toxic waste. During the current year, CAMANAVA MINING COMPANY has been sued
for environmental damage. A preliminary judgment of P10,000,000 was issued and is now under
appeal. The company's lawyer agreed that it is PROBABLE that the mining company, our auditee
will lose the appeal. As per our audit by what amount of PROVISION should be accrued as
liability?
A. 15,000,,000 B. P25,000,000 C P10,000,000 D None

4. The MIMAROPA COMPANY has several contingent liabilities on December 31, 2021. The
auditor obtained the following short description of each liability
* In May 2021, MIMAROPA became involved in litigation. In December 2021, the court
assessed a judgment against MIMAROPA for P1,800,000. The company is appealing the amount
of the judgment. MIMAROPA's lawyers believe it is PROBABLE that they can reduce the
assessment on appeal by 50%.
* In July 2021, MARIKINA City brought action against MIMAROPA for polluting the
Marikina River with its waste products. It is PROBABLE that Marikina City will e successful
but the amount of damages MIMAROPA might have to pay should not exceed P2,500,000.
Based on your audit and appreciation of the discovered data, what total amount should be
accrued as provision on December 31, 2021?.
A. 4,300,000 B. 2,500,000 C. 3,400,000 D. 1,800,000

5. On November 30, 2021, an implosion occurred at the factory building of CEBOOM

COMPANY in Novaliches City. Thereafter, an explosion ensued at the surrounding housing
settlement causing extensive damages to human habitat thereat. It was also caused by the
implosion at the factory. By January 16, 2022 claims have been asserted against CEBOOM and
their special counsel concluded that it is probable that CEBOOM will be responsible for the
damages and that P3,500,000 would be a REASONABLE ESTIMATE of its liability.
* CEBOOMs P10,000,000 comprehensive public liability policy has a P500,000 deductible
clause.
Based on your audit and data gathered, what should be reported in the December 31, 2021
financial statements to be issued on March 31, 2022?
A. A footnote disclosure indicating the PROBABLE LOSS of P500,000.
B. An accrued liability of P500,000
C. An accrued liability of P3,500.000
D. A disclosure indicating the probable loss of P3,500,000

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PROBLEM IV. DEBT RESTRUCTURING

1. In your audit of the financial statements of CHARIOT COMPANY, you noted that the auditee
is indebted to SPARTACUS INC. under a P5,000,000, 12 %, three year note dated December 31,
2019. Due to CHARIOT'S financial difficulties developing in 2021, Chariot owed accrued
interest of P600,000 on the note on December 31, 2021.
Under a debt restructuring agreement on December 31, 2021, Chariot agreed to settle the
note and accrued interest for a tract of land having a fair value of P4,500,000. Chariot's carrying
amount of the land is P3,600.000.
Ignoring income tax in its 2021 income statement, your audit should show by what amount
of gain on extinguishment is to be reported by CHARIOT as component of income from continuing
operations?
A. 900,000 B. 1,100,000 C. 1,400,000 D. 2,000,000

2. Your audit client, BULAKAN COMPANY, is experiencing financial difficulties and is

negotiating DEBT RESTRUCTURING with its creditors to relieve its financial stress.
BULAKAN has a P2,500,000 note p payable to METROPOLIS BANK. The bank accepted an
EQJITY interest with BULAKAN in the form of P200,000 ordinary shares quoted at P12 per share.
The par value is P10 per shares.
The fair value of the note payable on the date of restructuring is P2,200,000.

1. By your audit, what amount should be recognized as gain from debt extinguishment as a
result of the "equity swap"?
A. 200,000 B. 500,000 C. 100,000 D. 400,000
2. Per your audit, what amount should be recognized as SHARE PREMIUM from the issuance
of the share?
A, 200,000 B. 400,000 C. 100,000 D. 500,000

3. Another audit client, SLEEPING BEAUTY COMPANY, is threatened with bankruptcy due
to its inability to meet interest payments and fund requirements to retire P6,000,000 note payable
with accrued interest payable of P600,000. SLEEPING BEAUTY has entered with an
agreement with the creditor to exchange equity instruments for the financial liability The terms
of the agreement and exchange are 300,000 ordinary shares with P5 par value and P10 market
value, and P25,000 preference shares with P10 par value and P60 market value.

1. Based on your audit what is the gain on extinguishment of the note payable?
A. 2,750,000 B. 1,500,000 C. 2,100,000 D. None

2. As a result of the issuance of shares, what is the total premium from the issuance of Ordinary
and preference shares?
A. 2,100,000 B. 1,500,000 C. 4,850,000 D. 2,750,000

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 4. The PRINCE COMPANY has an overdue 8% note payable to MARIKINA BANK at
P8,000,000 and accrued interest of P640,000. As a result of a debt restructuring agreement on
January 04, 2021, MARIKINA BANK agreed to the following provisions:
* The principal obligation is reduced to P7,000,000
* The accrued interes of P640,000 is forgiven.
* The date of maturity is extended to December 31, 2024.
* Annual interest of 10% is to be paid for 4 years every December 31.
Note - the present value of 1 at 8% for 4 periods is 0.735 and the present value of an ordinary
annuity of 1 at 8% for 4 periods is 3.31.

1. What is the gain on extinguishment of debt to be recognized for 2021?

A. 538,000 B. 1,640,000 C. 1,178,000 D. 1,000,000

2. What is the interest expense to be recognized for 2021?

A. 640,000 B. 596,960 C. 700,000 D. 746,200

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