AUDIT OF SPECIAL LIABILITIES

PROBLEM 1

On January 1, 2023, PENSIONADO CO. has the following data relating to its defined benefit
plan:

Fair value of plan assets 2,600,000

Projected benefit obligation 3,200,000

During the year 2023, PENSIONADO CO. recognized the following:

Past service cost 400,000

Current service cost 1,200,000
Present value of PBO settled in advance 500,000
Benefits paid during the period 720,000
Actual returns on plan assets 160,000
Contributions to the fund 800,000
Settlement value of PBO settled in advance 400,000
Actuarial loss due to increase in PBO 200,000
Discount rate 12%

Questions:

1. How much is the fair value of plan assets as of December 31, 2023?
2. How much is the defined benefit obligation as of December 31, 2023?
3. How much is the net interest expense (income) during 2023?
4. How much is the defined benefit cost to be recognized in profit or loss in 2023?
5. How much is the defined benefit cost to be recognized in other comprehensive income
in 2023?
6. How much is the total defined benefit cost for 2023?
7. What is the journal entry to recognize the above transactions?
8. What is the balance of net retirement benefit liability (asset) as of December 31,
2023?
9. What is the amount if underfunding (overfunding), if any, as of December 31, 2023?

PROBLEM 2

On January 1, 2023, RETIRADO CORP. has the following data relating to its defined benefit
plan:

Fair value of plan assets 6,000,000

Projected benefit obligation 5,000,000

During the year, RETIRADO CORP. recognized the following:

Past service cost 400,000

Current service cost 500,000
Present value of PBO settled in advance 300,000
Benefits paid during the period 300,000
Actual returns on plan assets 680,000
Contributions to the fund 1,200,000
Settlement value of PBO settled in advance 350,000
Actuarial loss due to increase in PBO 160,000
Discount rate 10%

The present values of economic benefits in the form of refunds from the plan are P800,000
and P900,000 on January 1, 2023 and December 31, 2023, respectively.

Questions:

1. How much is the fair value of plan assets as of December 31, 2023?
2. How much is the defined benefit obligation as of December 31, 2023?
3. How much is the net interest expense (income) during 2023?
4. How much is the defined benefit cost to be recognized in profit or loss in 2023?
5. How much is the defined benefit cost to be recognized in other comprehensive income
in 2023?
6. How much is the total defined benefit cost for 2023?
7. What is the journal entry to recognize the above transactions?
8. What is the balance of net retirement benefit liability (asset) as of December 31,
2023?
9. What is the amount if underfunding (overfunding), if any, as of December 31, 2023?

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PROBLEM 3

The following data pertains to audit of income taxes of DIRTY TAX COMPANY:

I. At December 31, 2023, 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
2026 150,000
2027 690,000
2028 60,000
Total 900,000

II. The company uses different depreciation methods for financial reporting and tax
purposes. Consequently, at December 31, 2023, 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
2024 480,000
2025 480,000
2026 480,000
2027 480,000
2028 480,000
Total 2,400,000

III. The income tax rate for 2023 is 30% and 25% for future years.
IV. Taxable income for 2023 is P2,400,000. The company expects to report taxable income
for the next five years.
V. No temporary differences existed at the end of 2023.

Questions:

1. What is the deferred tax liability of DIRTY TAX COMPANY to be reported on the statement
of financial position at December 31, 2023?
2. What is the deferred tax asset of DIRTY TAX COMPANY to be reported on the statement
of financial position at December 31, 2023?
3. What is the current tax liability of DIRTY TAX COMPANY to be reported on the statement
of financial position at December 31, 2023?
4. How much is the total income tax expense of DIRTY TAX COMPANY to be reported on the
statement of comprehensive income for 2023?
5. How much is the pretax accounting income of DIRTY TAX COMPANY for 2023?
6. How much is the net income of DIRTY TAX COMPANY for 2023?

PROBLEM 4

In 2023, TAX-SIL COMPANY started to manufacture machined that are sold on installment basis.
TAX-SIL COMPANY recognizes revenue when equipment is sold for financial reporting purposes,
and when installment payments are received for tax purposes.

In 2023, the entity recognized gross profit of P6,000,000 for financial reporting purposes
and P1,500,000 for tax purposes. The amount of gross profit expected to be recognized for
tax purposes in 2024 and 2025 are P2,500,000 and P2,000,000, respectively.

The entity guaranteed the machines for two years. warranty costs are recognized on the
accrual basis for financial reporting purposes and when paid for tax purposes. Warranty
costs accrued in 2023 is P2,500,000 but only P500,000 of warranty costs is paid in 2023. It
is expected that in 2024 and 2025, P1,000,000 and P1,000,000, respectively, of warranty
costs will be paid.

In addition, during 2023, P500,000 interest, net of 20% final income tax, was received and
earned. Insurance premium of P100,000 on life insurance policy that covered the life of the
entity’s president was paid. The entity is the beneficiary for this policy.

Pretax accounting income in 2023 was P2,000,000. Any 2023 operating loss will be carried
forward to 2024. The income tax rate is 30%.

Questions:

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 1. What is the accounting income subject to tax?
2. What is the deferred tax asset on December 31, 2023?
3. What is the deferred tax liability on December 31, 2023?
4. What is the current tax expense for 2023?
5. What is the net deferred tax expense (benefit) for 2023?
6. What is the total income tax expense for 2023?

PROBLEM 5

On December 31, 2023, RENTA CO. signed a 4-year noncancellable lease for a new machine
requiring P120,000 annual payments beginning December 31, 2023. The machine has a useful
life of 8 years, with no salvage value. The rate implicit on the lease is 12%.

RENTA CO. has a purchase option amounting to P20,000. It is certain that the company will
exercise this option.

The fair value of the machine at the commencement date amounted to P447,794.

Questions:

1. How much is the initial measurement of lease liability?

2. How much is the initial cost of right of use asset?
3. How much is the interest expense for 2024?
4. How much is the lease liability to be presented in the current section of the statement
of financial position for 2024?
5. How much is the lease liability to be presented in the non-current section of the
statement of financial position for 2024?
6. How much is the depreciation of the right of use asset on December 31, 2024?

PROBLEM 6

On December 31, 2023, UPA COMPANY. signed a 4-year noncancellable lease for a right of use
of machine requiring P150,000 annual payments beginning December 31, 2023. The machine has
a useful life of 8 years, with no salvage value. The rate implicit on the lease is 10%.

UPA COMPANY guarantees a residual value of P50,000 at the end of the lease term.

The fair value of the machine at the commencement date amounted to P518,561.

Questions:

1. How much is the initial measurement of lease liability?

2. How much is the initial cost of right of use asset?
3. How much is the interest expense for 2024?
4. How much is the lease liability to be presented in the current section of the statement
of financial position for 2024?
5. How much is the lease liability to be presented in the non-current section of the
statement of financial position for 2024?
6. How much is the depreciation of the right of use asset on December 31, 2024?

PROBLEM 7

The following are independent situations related to the audit of rental income of LANDLORD
COMPANY:

On January 1, 2023, LANDLORD INC., lessor, entered into a 3-year nonrenewable operating
lease, commencing on that date, for office space.

SITUATION 1: The office space has a monthly rent of P25,000.

SITUATION 2: The lessee company made the following payments on January 1, 2023:

Bonus to obtain the lease 180,000

One year’s rent 300,000
Last month’s rent 25,000

SITUATION 3: The office space has a monthly rent of P25,000, and the lessee received a grant
of six months free rent.

SITUATION 4: the lessee company made the following payments on January 1, 2023:

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 Rent per month for the first two years 25,000
Rent per year for the last year 30,000

SITUATION 5: The office space has a monthly rent of P25,000 and LANDORD INC. incurred the
following:
Initial direct costs 120,000
Insurance and property taxes 40,000
Depreciation of the lease asset 30,000

SITUATION 6: The office space has a monthly rent of P25,000. In addition to the monthly
rent, the lessor and lessee agreed on the following additional rent:

Rate Net sales over Up to

10% 1,500,000 2,500,000
8% 2,500,000

The total net sales for 2023 were P6,000,000.

Questions:

1. Determine the net income under the following independent situations.

2. Determine the rent receivable under the following independent situations.

PROBLEM 8

LANDLADY CORP., a lessor, entered into the lease of equipment to different lessees. The
following are information in relation to its leases:

I. On January 1, 2023, LANDLADY CORP., which is a dealer of machines, leased a machine

to LESSEE #1. The asset reverts to LANDLADY CORP. at the end of the lease term. Data
relating to the lease is as follows:

Cost of the machinery 900,000

Useful life of equipment 5 years
Lease term 4 years
Annual rent payable at the end of the year 300,000
Interest rate implicit in the lease 8%
Residual value 50,000
Initial direct cost 10,000

II. On December 31, 2023, LANDLADY CORP. leased an equipment with a cost of P1,000,000 to
LESSEE #2 for 4 years which is also the useful life of the asset. The lease agreement
specifies equal annual payment of P261,694 beginning on December 31, 2023. At the end
of the least term, the equipment will revert to LANDLADY CORP. a third party to the
lessee guarantees the residual value of the equipment amounting to P150,000. The rate
implicit on the lease is 11%.

Questions:

Under situation I:
1. How much is the total interest income to be earned over the lease term?
2. How much is the total interest income in 2023?
3. How much is the gross profit on sale on December 31, 2023?
4. Assuming the residual value decreased by P6,000, how much is the loss to be recognized
in profit or loss at the end of the lease?

Under situation II:

5. How much is the total interest income to be earned over the lease term?
6. How much is the total interest income in 2024?
7. How much is the leased-related asset to be shown in the current section of the
statement of financial position on December 31, 2023?
8. How much is the leased-related asset to be shown in the non-current section of the
statement of financial position on December 31, 2023?

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